Pound shrugs off Brexit fears as price rises come to the fore
City Index March 21, 2017 2:00 PM
<p>Price data in the UK rose faster than most economists expected last month, with headline prices rising at 2.3%, while core prices rose to 2%. […]</p>
Price data in the UK rose faster than most economists expected last month, with headline prices rising at 2.3%, while core prices rose to 2%. This is significant, not only are prices above the BOE’s inflation target, but headline inflation is now at the same level as UK wage growth. If CPI continues to march higher as expected then living standards will be eroded.
Will prices spook the BOE to hike rates “early”?
This latter point is a major concern for the Bank of England. We mentioned last week after one BOE member, Kirsten Forbes, broke ranks and voted for a rate hike, that if it weren’t for Brexit the BOE probably would have followed the Fed and hiked interest rates. Now that inflation is starting to rise sharply, the question is will the BOE try to protect living standards and bring inflation down by raising interest rates?
Right now, the market doesn’t think so, with only a 30% chance of a rate hike by year-end. We also noted last week that there are now two spots up for grabs on the MPC Committee, if they are filled by inflation fighters we could see the BOE hike rates much sooner than expected even while the government negotiates our exit from the EU, which could cause a major readjustment in UK asset prices.
The future looks bright for GBP
This data has been good news for the pound, which has surged to fresh highs at 1.2460, which is the highest level since late February. Today’s data has also boosted UK Gilt yields, which is further helping the recovery in the UK-US 10-year yield spread, which is also at its highest level for a month, and is a key support for GBP/USD. EUR/GBP is also under pressure, while GBP/AUD is also picking up after reaching four-month lows late last week, as weaker commodity prices weigh on the Aussie.
Stocks take fright at higher prices
It’s a different story for the FTSE 100, which is under pressure today. Rising prices are toxic for stocks; the FTSE 250 has been hit even harder than the FTSE 100 this morning, after making a record high on Monday.
The top performers in the FTSE 100 today are Barclays and Royal Mail, arguably two companies who are less sensitive to rising prices. Companies under pressure include commodity producers– due to weaker commodity prices – and Associated British Foods, which is a sensitive to rising prices, as they could temper consumer demand.
Two potential outcomes from rising prices
Going forward, the theme of rising prices could go two ways. Firstly, if oil prices continue to fall then we could see inflation pressures start to recede, which may boost consumer stocks and weigh on the pound. If, however, we continue to see prices rise and wage growth disappoint, then we could see further upward pressure on the pound and UK Gilt yields, along with more downward pressure on UK consumer stocks.
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