Conor Beakey
August 18, 2021

UK Inflation Disappoints, Attention Turns To Fed Meeting Minutes

Sterling

Sterling remained on the backfoot yesterday, with cable dropping by 0.9% down to three-week lows near $1.373 and GBP/EUR retreating into the lower half of the €1.17-1.18 range. This was despite the release of strong UK labour market data for Q2, which in our view boosted the case for BoE interest rate hikes in 2022. Markets, however, were spooked by developments in Asia-Pacific, with New Zealand re-entering lockdown after its first positive Covid case in six months, while Japan extended its current state of emergency until September 12. This weighed heavily on investor sentiment, which was already fragile after the release of soft Chinese economic activity over the weekend. It was the emergence of this risk-off tone that saw sterling come under pressure.

This morning, UK CPI figures for July came in modestly below expectations, though the figures were heavily distorted by base effects and one-off factors. Headline inflation eased to 2.0% y-o-y as the index flat-lined m-o-m, on the back of clothing sales, an oddly large fall in erratic items (computer games) and imputed prices (package holidays). With the labour market continuing to tighten, supply chain disruptions persisting and base effects associated with the Help Out To Eat Out scheme and the reversal of a temporary VAT cut, we expect that price pressures will pick back up in the coming months. Against this backdrop, we see limited risk of markets moving to price out BoE rate hikes in the near term, which we believe will ultimately help allow the sterling resume its uptrend against both the euro and the dollar. Today, a rebound in risk appetite could help push sterling higher.

Dollar

The dollar remained on the front foot yesterday as the currency benefitted from safe-haven flows, with EUR/USD trading back down toward the $1.17 threshold. Somewhat paradoxically, the dollar saw additional support following the release of a weak retail sales report for July, as it contributed to the global growth concerns that had seen risk appetite deteriorate. The data add to the evidence that US activity decelerated notably in Q3, with previously released confidence figures suggesting consumer spending decelerated further in August. While August will be a Covid story, the softness in July was more a function of product shortages (namely cars), the ongoing shift from goods to services spending as the economy has re-opened (note that sales are 17.2% above pre-pandemic levels), and due to the fact that consumers brought expenditure to take advantage of Amazon Prime Day in June.

We also heard from Fed Chair Powell last night, but as expected he failed to signal any shifts in policy. The central bank chief’s patient approach has been bolstered by incoming US macro data, suggesting that the recovery may be rockier than consensus expects. The focus will remain on the Fed today, with minutes from July’s policy meeting due. While we expect that they will be a non-event, given they are quite dated at this point, we note that if there are any signs that the Fed began a technical discussion of tapering in July, the dollar could build on its gains as it would suggest the process could begin as early as September.

Euro

There is little to report on the euro front, though the eurozone’s large current account surplus has seen it weather the recent dip in investor sentiment reasonably well.