British Pound, Equities Prepare For Inflation's Contribution To Further Hikes

UK CPI (YoY) (FEB) (9:30GMT; 5:30EDT)
UK RPI (YoY) (FEB) (9:30GMT; 5:30EDT)
Expected: 2.7%
Expected: 4.3%
Previous: 2.7%
Previous: 4.2%

How Will The Markets React?

While fixed income and equity markets in the UK have been following the finicky flight-to-safety lead of global markets, the British pound has managed to make a comeback after plunging to three month lows in early March. However, economic data may start to make an impact on UK markets once again as signs are expected to emerge that price growth is on the rise. While headline CPI is anticipated to hold steady at 2.7 percent, both RPI and Core CPI are expected to tick higher to 4.3 percent and 1.7 percent, respectively. In fact, data over the course of the past week has done nothing but point to mounting inflationary pressures, as the producer price index reflected rising input and output levels while average earnings unexpectedly jumped to 4.2 percent from 4.0 percent. With inflation seeping into the economy not only from the factory gate, but via wages as well, traders may start to speculate that the Bank of England will tighten monetary policy another 25 basis points to 5.50 percent. While UK Gilts would plunge lower on such prospects, FX traders may show the strongest reaction and will likely send the British pound reeling as interest rates in the US and UK – which currently sit at parity – would shift as to make the carry differential to the benefit of Cable longs. Wednesday’s FOMC meeting could stop any Sterling rally dead in its tracks, though, as a hawkish leaning by the US central bank could easily take priority and lead the greenback to retrace its recent losses.
Bonds –10-Year Long Gilt Futures
UK fixed income trade has been a major beneficiary of risk aversion following the late-February collapse of global equity markets. Indeed, 10-year Gilt futures rallied towards the 110.00 level, but subsequently eased back from resistance. Nevertheless, price remains contained in a trending channel with support hovering below at the March 12 low of 108.98. Will Gilts remain on the uptrack? Not if a jump in price growth comes to fruition. Given the recent pickup in average earnings and producer prices, CPI and RPI are likely to hit estimates and could spark speculation that the Bank of England’s April monetary policy committee meeting could bring about a rate hike to 5.50 percent.

The British pound has held uncharacteristically small ranges against the US currency in the past few months - perhaps lending to the parity in the two nation’s overnight lending rates. However, the depressed levels of volatility may find some relief soon, whether it be in favor of the dollar or the cable. Looking ahead to the coming days, both the US and UK economic calendars hold a number of indicators that can alter the market’s outlook for the future of monetary policy and interest rate spreads.
From the US calendar, a number of housing reports and a FOMC rate decision will play a leading role GBPUSD moves. Concerns over the US housing market has quickly risen to the top of the market’s list in recent weeks as the collapse in the local sub-prime mortgage market has led revived fears that the sector will extend its worst contraction in over 15 years. What’s more, these numbers could directly influence the Fed’s policy meeting, as the Board of Governors measures consumers’ ability to handle current rates through a sharp rise in defaults. Officially, economists are consistent in their outlook for a pass on changing rates, but a failure to soften their hawkish bias may speak volumes as it would suggest few things outside of inflation can necessitate a change in monetary policy. Across the Atlantic, the market will absorb February inflation numbers. Though the Bank of England has just come off of a policy meeting - in which the MPC decided to pass over a move – currency traders will be quick to jump on fodder for the April outlook. Both the consumer and retail price indices will play an integral role in guiding the central bank’s next step. Bank in January, the BoE was concerned with the current level of price growth and the possible effects of wage negotiations. Heading off further pressures, the policy group decided to lift benchmark rate to 5.25 percent. In response, both the inflation gauges corrected on the month. However, if CPI and RPI prove stubborn and rebound in February, expectations for a rate hike may increase dramatically.

Equities – FTSE 100 Index[/B]
UK equities followed the global trend and printed a strong advance Monday morning. Adding 58.80 points, or 0.96 percent, the benchmark FTSE 100 Index is well on its way to making a second run on the 6,276.30 resistance level that held back an advance earlier in the month. Though stock markets around the world were surging on the week’s open, the UK found its own fuel for an aggressive rally. The biggest headline for the day were early reports that UK-based Barclay’s is in exclusive talks to take over ABN Amro in what would be the largest merge between financial service companies ever. According to Bloomberg, the market cap for ABN at the current market price is 56 billion euros though there is discussion that the final figure will be well beyond this level. Though this represents only one deal, its closing successfully could single-handedly revitalize a bullish outlook for the local equity market as it would suggest that there is still confidence among business leaders that there is room for revenue growth and that they are willing to pay the premium for it.
While this deal plays out in the days ahead, the market will find a more pressing distraction in macro economic data. Scheduled for release for 9:30 GMT, the government statistics body will release CPI and RPI. Both indicators marked a considerable correction in January after the Bank of England lifted the nation’s overnight lending rate to 5.25 percent. However, with the current outlook for February’s numbers, the threat of another hike may through stock traders into a panic. The MPC’s decision to lift the overnight cash rate (OCR) in December was primarily in response to the price gauges running consistently above the bank’s tolerance levels. If those indicators bump right back to the high levels in February, it could lead policy officials to believe that current rates are not high enough to cool inflation natural. Such a policy shift would weigh on revenue and profit forecasts significantly. Not only would the boost in rates impact business investment, it could seriously cut consumer spending.