British Pound, Equities Look To The MPC For Probabilities On Another Hike

Average Earnings (3M/YoY) (08:30 GMT)
BoE Quarterly Inflation Report (09:30 GMT)
Expected: 4.8%
Expected: N/A
Previous: 4.6%
Previous: N/A

How Will The Markets React?

British data was the center of attention Tuesday and it looks as if it will dominate the calendar yet again tomorrow. Amid a slew of economic indicators from the Euro Zone, US and Canada, the British inflation numbers this morning had the greatest potential for market impact. While the Consumer and Retail Price Indices stirred little reaction from the financial markets, they do have greater implications for monetary policy and the probability of another rate hike this year. The Consumer Price Index for April certainly sets the tone for the OCR outlook. The year-over-year gauge cooled from its decade high 3.1 percent pace in March to 2.8 percent last month. At the same time, the RPI number for the same period slowed from an incredible 4.8 percent gait to 4.5 percent. Both of these pullbacks were right in line with expectations; yet they are interesting in that they actually precede last week?s rate hike. Remember, the inflation numbers prompted BoE Governor Mervyn King to write a letter to Chancellor Gordon Brown explaining why inflation is so high and what would be done to bring it back in line. Therefore, it is not a stretch to say the two inflation numbers were ultimately responsible for the rate hike. So did the hike come a little too early? Tomorrow?s quarterly inflation report from the Bank of England will provide an answer to that question. The Monetary Policy Committee projected in February that inflation would ‘likely?fall back quite sharply this year? to its 2 percent target. Surely there is a clear argument to the contrary. The price indices have made little headway in a pullback aside from last nights data. At the same time, this pull back and the additional efforts to remove liquidity should be factored into their forecast. Also of importance for the day are the jobless claims change for April and the average earnings number for the previous month. Earnings could contribute to the inflation debate, but its lag opens the door to an unfettered surprise from employment.
Bonds - 10-Year Long Gilt Futures
The early slide below 106.50 in the benchmark gilt proved to be a prophetic move. Instead of having pressure build into the wedge that was forming on the 10-year gilt futures chart, yields advanced early on rather unimpressive PPI numbers. Today?s price action was just as counterintuitive with the contract holding its lows despite the pull back in the retail and consumer price indices helping to ease expectations further rate hikes. The stable pricing may be in recognition of events scheduled for release tomorrow. While today?s inflation reports were ultimately unsurprising, Wednesday?s quarterly report will likely be news to the market regardless of what lean it provides. What?s more, employment and earning numbers will add additional event risk for an altogether fully stocked session.

Former support has now become resistance for GBP/USD, as the pair?s gains on the back of US dollar weakness were capped at the 1.9860 level. Looking ahead, tomorrow?s release of Average Earnings and the Bank of England?s Quarterly Inflation Report could prove critical to the Cable?s next move, as traders gauge whether or not another rate hike by the BOE should be priced in to the national currency. Average Earnings are anticipated to rise to 4.8 percent from 4.6 percent, which would only stir inflation hawks? fears that wages will filter into consumer prices. However, the BOE Inflation Report will be even more important, as markets will look to see if the central bank has changed their outlook. The BOE is likely to maintain their concerns about upside risks to CPI, which would only hammer in the sentiment of stronger Average Earnings and quickly ramp up expectations of a rate hike in June to 5.75 percent while sending GBP/USD up towards 2.000. On the other hand, a softer than anticipated Inflation Report on the back of Tuesday?s easing in UK CPI could leave the British pound cowering away from resistance and falling to 1.9750.

Equities - FTSE 100 Index
UK equities ended the day mildly higher, as softer inflation figures helped take the edge off of hike expectations for the Bank of England. The benchmark FTSE 100 added 0.2 percent to close at 6,568.60, with Reuters leading the gains. Shares of the firm rose 3.4 percent to 626 pence after Thomson Corp. said it agreed to acquire the world’s biggest publicly traded provider of financial data for about 8.7 billion pounds in cash and stock. The companies also said that shareholders of Reuters will get 691 pence in cash and stock for each share.
Shares in the FTSE 100 could be rattled Wednesday morning as the market will be hit with two rounds of pertinent releases: Average Earnings and the BOE Quarterly Inflation Report. Average Earnings are anticipated to pick up to 4.8 percent from 4.6 percent, which would only exacerbate the concerns of inflation hawks that wage growth will eventually seep into consumer prices. The subsequent release of the Inflation Report may only drive this sentiment home, as the central bank will likely call for a decline in CPI over the next few months, but upside risks later in the year. UK equity traders will not take kindly to such insights, and the FTSE 100 could take the heat and drop towards 6,500.00. On the other hand, a significantly less hawkish stance by the BOE would offset any gains in Average Earnings and could propel the benchmark index towards the highs nears 6,615.00.