Sterling Deflates as CPI Eyes 2008 Pattern

<p>UK April inflation hit a 2-year low of 3.0% (lowest since February 2010) from 3.5% in March, while the annual core CPI (excluding energy, food […]</p>

UK April inflation hit a 2-year low of 3.0% (lowest since February 2010) from 3.5% in March, while the annual core CPI (excluding energy, food & alcohol), slowed to 2.1% from 2.5%, reaching its lowest since November 2009.

The UK inflation picture looks increasingly similar to the cycle in 2008-09, when CPI peaked at 5.2% in September 2008 before plunging to a 4-year low of 1.1%. A fresh 5.2% peak was reached in September 2011 before slowing back to 3.0%.

Equally significant, is the rapid breakdown in core CPI, which fell 140 bps in the last six months (from 3.5% to 2.1%), reflecting the widening contrast between energy and alcohol items relative to headline inflation. If the current trend remains (and continues to reflect that of 2008-09), then 1.5% on the core could be reached before year-end, prompting the headline CPI to reach the BoE’s 2.0% target as early as Q4 of this year. Markets await more UK indicators this week, with Wednesday’s release of the May CBI survey on industrial orders expected to dip to -11 from -8, and Thursday’s release of UK April retail sales (ex-auto fuel) seen slowing to 1.2% from 3.3%. If the revised Q2 GDP confirms the previous reading of -0.2%, then sterling and gilt yields could be in for prolonged losses.

GBP/USD extends losses after last week’s break of its 4-month trendline support at $1.5950. Momentum is deteriorating as cable fails to regain its 200-week MA of 1.58remains below the 200-week MA and 100-week MA at $1.5860 and dips back to $1.5760s. GBP/USD monthly chart suggests further downside towards $1.5450s as long as the $1.60 resistance holds successfully.

UK Inflation & GBP/USD Monthly


EUR/USD remains on track to re-test this year’s $1.2626 low, as long as the inability to recover above $1.28450-considered as a short-term resistance. Ever since the EUR/USD began its third downcycle (from last year’s peak of $1.4940), the pair’s rebounds have been limited at 8% (in October). As these rebounds subside, we expect selling momentum to intensify in late summer and into $1.20. In order for EUR/USD to reproduce the 22% declines in the prior two cycles of 2008 and 2010, the pair would have to reach $1.16, which would be a the lowest since 2003.

10-year gilt yields lost 4 bps to 1.85%, continuing to remain well below their trendline support extending from the March high. As long as the failure to take out the 1.95% barrier remains, we expect gilt yields to test the 1.80% floor.

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