UK Inflation and its Impact on Monetary Policy
The Pound has had a very good run recently against a number of major currencies including both the US Dollar and the Euro.
Pound Sterling Euro exchange rates hit their best level to buy Euros since March 2020 as the Pound has continued to fight back vs the single currency.
The Pound has made gains as it appears as though the stance recently taken by the Bank of England may now start to soften with a potential interest rate hike by 0.15% on the cards in the near future.
Inflation has remained much higher than the target set out by the Bank of England and although it could be argued that inflation is high due to the issues surrounding the global pandemic, energy prices have continued to spiral in an upwards direction.
Typically, if a country or economic area struggles with high inflation then the common policy is to adopt an interest rate hike to bring down inflation. An interest rate hike also often tends to support the currency in question and in this case the Pound is reflecting this expectation.
Bank of England governor Andrew Baily was recently cited as saying ‘I am concerned with inflation above target’ so this could give rise to a potential rate hike when the Bank of England meets next month.
The target level for inflation in the UK to 2%. With inflation remaining too high for too long, it could be inevitable that we see a rate hike for the UK. The real question is how long before this rate hike takes place?
On Wednesday morning we see the next release of the latest UK inflation figures due out. Last month the figure came out at 3.2% so anything similar or higher could increase the chance of a rate hike in the UK coming sooner rather than later and this could give some further support to Sterling exchange rates if this happens.
Euro under pressure against Sterling and the US Dollar
Whilst the expectations are increasing that a rate hike could come for the UK the Eurozone appears to be adopting a very different approach to their own monetary policy.
The President of the European Central Bank, Christine Lagarde, has suggested that any change to monetary policy could cause problems for the speed to the economic recovery and could also cause unemployment to potentially rise.
Therefore, if we put monetary policy side by side of the Bank of England compared to the European Central Bank, the outlook could not be more different.
What we are seeing is Pound strength caused by the expectation of an interest rate hike combined with weakness for the Euro caused by the ECB’s cautious stance to monetary policy.
In recent years monetary policy with the US, UK and Eurozone have often tried to keep their policies relatively similar. In essence, once one central bank cuts rates the others have followed and also when rates have seen an increase they have also shared a similar pattern.
Therefore, although it could be expected that the UK will hike rates quicker than the Eurozone, the ECB could potentially consider following the Bank of England’s lead in the future.
Eurozone inflation is also released on Wednesday, shortly after the UK’s data release so expect to see a very busy morning for Euro exchange rates on Wednesday.
The Euro is now at its lowest level to buy Sterling in 19 months which is creating some excellent opportunities for those clients looking to send money to Europe at the moment.
To end next week, the Eurozone will announce its latest Manufacturing and Services data and both measurements will signal how strong the economy is currently performing so any signs of a slowdown could see further Euro weakness to end the week for the single currency.
When will the Fed increase interest rates?
The US Dollar has been weakening against the Pound recently but remains very strong vs the Euro which is in turn, moving GBPEUR exchange rates in an upwards direction. The US economy has been providing some inconsistent economic data recently after some poor unemployment data confirmed by the latest US Non-Farm payroll data.
The recovery of the US has predicted to see some signs of slowing down which has caused the US Dollar to weaken vs Sterling.
However, as inflation remains much higher in the world’s leading economy it appears as though it is only a matter of time before the US Federal Reserve considers changing its current monetary policy.
The current expectation is that the Fed are likely to start hiking rates during the middle part of 2022.
Indeed, US inflation is the highest since the credit crunch back in 2008 which has, like the UK, felt the brunt of higher energy prices as the world opens up from lockdown.
The Fed are due to meet in November and if there are any hints as to changing the current plan and an interest rate hike appears more likely then we could see the Dollar begin to fightback once again.
At the end of last week, the inconsistent economic data for the US continued in the form of US Retail Sales. Although the figures were lower than last month, they still beat the estimates which caused the Dollar to strengthen further against the Euro as well as vs the Pound.
Moving the focus towards this week and the US will announce further employment news with the latest set of Jobless Claims so make sure you pay close attention to the data due out later this week as this may provide clue to the speed of the US economic recovery.
This blog post is intended to provide you with information on the services Lumon Pay Ltd (“LPL”) offer and should not be interpreted as advice or as a solicitation to offer to buy or sell any currency or as a recommendation to trade. Foreign exchange rates provided therein are for indicative purposes only and are not intended to give an accurate reflection of current currency exchange rates or to predict future movements in currency exchange rates. LPL, trading as Lumon, is a company registered in England with its registered address at Building 1, Chalfont Park, Gerrards Cross, Buckinghamshire SL9 0BG. LPL is authorised by the Financial Conduct Authority as an Electronic Money Institution (FRN: 902022).