GBP/USD slides as dismal UK inflation suggests negative rates possible

GBP/USD slides as dismal UK inflation suggests negative rates possible
  • The GBP/USD declined slightly after disappointing CPI data from the UK.
  • The headline CPI dropped by 0.2 per cent in April moving away from the BOE target.
  • The market will now focus on BOE governor Andrew Bailey testimony to parliament.

The GBP/USD pair declined slightlyafter the UK inflation declined to its lowest level since February, moving away from the Bank of England (BoE) target of two per cent. This suggests that the BOE will implement negative rates this year.

GBP/USD falls
GBP/USD falls after dismal inflation data

UK CPI data disappoint

According to data from the Office of National Statistics (ONS), consumer prices rose by 0.8 per cent from a year ago and declined by -0.2% from March. These figures were below the 0.9 per cent and -0.1 per cent that analysts polled by Reuters were expecting.

In a statement, the ONS said that housing, water, and fuels contributed to the decrease of consumer prices. These declines were partially offset by an increase in restaurants and hotels, recreation and culture, alcohol and tobacco, and housing and household items. The statement said:

“The introduction of the Office of Gas and Electricity Markets’ (Ofgem’s) initial energy price cap resulted in reduced contributions to the CPIH 12-month inflation rate for January to March 2019.”

The so-called core CPI, which excludes the volatile food and energy prices, rose by 1.4 per cent from a year before and by just 0.1 per cent from March.

Meanwhile, the Retail Price Index (RPI) rose by 1.5 per cent on an annualised basis and remained unchanged from a month before.

Pressure on Bank of England

The low inflation numbers add more pressure to the Bank of England, which recently decided to leave interest rates unchanged. In its meeting, the bank left the current £200 billion quantitative easing program unchanged. Still, analysts expect the monetary policy committee to add into this program in the upcoming meeting.

The central bank’s officials have sent mixed signals on negative interest rates. In an interview last week, Governor Andrew Bailey said that the bank was “not contemplating” interest rates. He said this a few days after his deputy, Ben Broadbent, said that the bank must consider lowering rates to the negative territory. He said:

“We keep under review all our potential policy tools and this is a question that’s been thought about on and off since the financial crisis and it’s a balanced judgment. It is quite possible that more monetary easing will be needed over time.”

Still, there is no evident that negative interest rates can help to contain deflation. For example, in Japan, inflation has been inexistent even after years of negative rates.

It also adds pressure to the British pound (GBP/USD), which has been targeted by short sellers in the futures market.

The BOE chair, Andrew Bailey, will testify before parliament today.

UK removes tariffs

The GBP/USD also moved in reaction to the tariffs news released yesterday. In a statement, the government said that it would remove tariffs on most items in the coming year. The government will remove tariffs on items like dishwashers and freezers. The new tariff regime will affect goods worth more than $36.6 billion.

The UK will leave tariffs on vital industries like agriculture and cars in place. In a statemenr, the Society of Motor Manufacturers and Trade said:

“We must avoid any tariffs or barriers that add cost and reduce choice for consumers, and which would result in like-for-like barriers to export, undermining U.K. manufacturing competitiveness.”

In the meantime, the biggest challenge for the British pound (GBP/USD) is Brexit. The country is yet to seal a free trade agreement with the European Union.

The third round of talks will begin in June but there are signs that the two sides will not reach a deal. The UK has said that it wants a free trade agreement similar to the one the EU has with Canada. The EU has rejected this, citing the volume of trade involved as shown below. The two sides have also disagreed on fisheries, with the UK insisting that it wants control for its rich fishing waters.

UK trade data

GBP/USD technical forecast

GBP/USD
GBP/USD technical forecast

The GBP/USD is trading at 1.2266, which is slightly above yesterday’s low of 1.2080. On the daily chart, the pair is forming a three white soldiers pattern, which is usually bullish. Also, the price is along the 38.2 per cent Fibonacci retracement level, which is also along the neckline of the head and shoulders pattern. I expect bulls to attempt to test the 50-day EMA and the psychologically-important 1.2400 level.

By Crispus Nyaga
Crispus Nyaga is a finance analyst and trader with more than 7 years industry experience. He's contributed to some of the leading financial brands in the world including Seeking Alpha, MarketWatch, Forbes, and Investing.com. Crispus has an excellent understanding of global macroeconomic and geopolitical issues, is a big fan of golf, and lives in Nairobi with his wife, son, and nephew.
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