British Pound May Target 2.00 Once Again If Inflation Fails To Soften

Consumer Price Index (YoY) (MAY) (08:30 GMT; 04:30 EST)
Retail Price Index (YoY) (MAY) (08:30 GMT; 04:30 EST)
Expected: 2.6%
Expected: 4.3%
Previous: 2.8%
Previous: 4.5%

How Will The Markets React?
Only UK equity markets saw noticeable price action on Monday as the sell-off in 10-year Gilts and the British pound finally took a break. However, with market-moving data on tap on Tuesday, traders could be in for a wild day. UK inflation reports are anticipated to show that price pressures continued to ease back during the month of May, with CPI estimated to hit 2.6 percent and RPI forecasted to slip to 4.3 percent. Nevertheless, even those figures are lofty, especially as the Bank of England?s official inflation target is well below at 2.0 percent. Furthermore, BOE Governor Mervyn King recently expressed an even more hawkish tone during a speech given in Wales, in which he said that the BOE “may need to take further action” on inflation as expectations have “drifted up.” As a result, CPI figures confirming King?s commentary will really ramp up speculation of a July hike by the central bank. On the other hand, if inflation reports actually hit the tape at softer-than-expected levels, the BOE will be more likely to continue watching pricing and capacity data in order to assess whether policy tightening will be necessary in August.
Bonds - 10-Year Long Gilt Futures
Gilt futures edged higher today, showing a mild recovery from the steep drops we?ve seen over the past few weeks. However, with the Bank of England widely perceived as maintaining a hawkish stance, Gilt bulls have been reluctant to extend the bounce and there is still a long way to go before this is anything more than just a brief correction. On the intraday charts, the 50.0% fib of 104.08 - 104.65 at 104.36 has served as decent support, with Long Gilt Futures wrapping up the session at 104.45. However, given the tightening bias of the BOE, the release of UK inflation data could reignite the steep descent if CPI remains elevated. On the other hand, if markets find that price pressures have let up more than anticipated, Gilts could make a stealthy advance towards 105.00, as yields would be inclined to plummet on the drop in rate hike expectations.

On Tuesday, GBPUSD could be in for a bounce based on both technical and fundamental factors. Looking at the daily charts, last week?s plunge was stopped short at seven month trendline support and the 50.0% fib of 1.9183-2.0131 at 1.9657. Should GBPUSD hold up against support, price could bounce up towards 1.9775 with the help of strong economic data. While inflation reports are anticipated to ease back, CPI and PPI are also projected to remain elevated and could underpin the case for a July or August hike, depending on how strong price pressures remain, especially after BOE Governor Mervyn King said that the central bank “may need to take further action” on inflation. On the other hand, if we see that CPI falls closer to the 2.0 percent target than markets are expecting, GBPUSD could break down through support to target 1.9500. There are other major UK releases due out this week, and on Wednesday, signs of further tightening in the labor market will feed into concerns of mounting wage pressures. Furthermore, Retail Sales are forecasted to rebound on Friday, signaling that consumption remains healthy despite higher interest rates. However, with BRC Retail Sales for the same month indicating a sharp slowdown, there are major downside risks for this particular release. Nevertheless, should speculation about the BOE?s future policy action remain the dominant theme in British pound trade, GBPUSD gains may resume.

Equities - FTSE 100 Index
Equities in the UK rallied as the benchmark FTSE 100 Index gained 1 percent to 6567.5 in London, with all but 10 stocks rising. Rio Tinto, the world’s third-largest mining company, climbed 2.6 percent to 3,592 pence as base metals such as copper advanced in London and New York. Similarly, BHP Billiton, the world’s biggest mining company, surged 2.8 percent to 1,303 pence. The gains were only exacerbated after UBS AG said mergers and acquisitions in the mining industry will likely accelerate.
Whether the FTSE 100 continues to ascend towards its June 5th highs of 6,686.60 will depend greatly on the outcome of inflation figures on Tuesday. Both CPI and RPI are estimated to ease back, which could remove some of the BOE?s hawkish bias and leave equity traders more optimistic that rates will not be raised again in the short-term. However, should the inflation reports prove that price pressures are stronger than expected, the FTSE 100 could easily sell-off towards the 6,500 level, especially after BOE Governor Mervyn King said that the central bank “may need to take further action” on inflation.