UK inflation is rising, but pressure eases down the curve

<p>UK CPI was driven to its highest level since October 2014 last month by rising clothing and fuel prices. Recreational and cultural goods and services, […]</p>

UK CPI was driven to its highest level since October 2014 last month by rising clothing and fuel prices. Recreational and cultural goods and services, potentially driven by rising tourism rates, also contributed to the rise in prices. Apparently data processing equipment is getting more expensive too (according to the ONS), which could be driven by the fall in the pound. Basically, this report is probably the start of things to come for the UK inflation rate, we expect further increases in CPI throughout 2017.

Should we be concerned about the decline in producer prices?

One thing worth noting, producer input prices fell by 1.1% in November, led by a decline in petroleum product prices last month. Although the annual rate was still an impressive 12.9%, this was weaker than the 13.5% expected. Producer prices usually feed through to CPI, so if producer prices continue to fall, could the pace of gain in UK CPI rates be slower than currently expected? We will need more than one months’ worth of data to find out, but if we see another month of decline in the PPI rate then the rise in CPI may take longer to play out than currently expected.

GBP’s rally not supported by interest rate expectations

The market impact: GBP/USD broke above 1.27, back to last week’s highs, the level to beat is 1.2775 – the high from 6th Dec. If we get above this level then it would leave the pound in a strong position heading into the Fed meeting. The interest rate market (OIS swap rates) has largely been unaffected, with an interest rate hike still not forecast until end of 2018. Do interest rate swap traders see UK inflation rising at a slower pace than currently forecast for 2017? Perhaps, FX traders would be wise to keep an eye on interest rate expectations for the UK, if they don’t shift forward then it is hard to see how the pound can truly sustain a meaningful rally in the medium-term, especially if we get a hawkish Fed tomorrow.

It is also worth noting that forecasts for UK CPI could be a little off in the coming months, as it is difficult to calculate the exact effect on the fall in the pound on prices on a monthly basis. Thus, we could see some more volatility in this data in the future.

A little note on Unicredit

On a separate note, Unicredit is killing it on the stock market today, up an impressive 13% as the market gives a big thumbs up to its recapitalisation plans. There is still life in Italy’s banking sector yet, even if Unicredit has to cut nearly 1,000 branches in Italy and 16,000 staff globally. This is helping the FTSE MIB to lead the European pack today, it is already up 1.5%. However, all European indices are rising this morning, however, we expect only a cautious rally as we wait with bated breath for the FOMC meeting tomorrow.

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