GBP/USD: Will UK CPI Send The British Pound Back To 2.00?

[B]AUG 14[/B]
[B]UK[/B][B] CPI (MoM) (JUL) (08:30 EST; 12:30 GMT)[/B]
[B]UK[/B][B] CPI (YoY) (JUL) (08:30 EST; 12:30 GMT)[/B]
[B]Expected: -0.2%[/B]
[B]Expected: 2.3%[/B]
[B]Previous: 0.2%[/B]
[B]Previous: 2.4%[/B]

[B]How Will The Markets React?[/B]
Inflation growth in the UK is expected to slow during the month of July, with the headline CPI figure estimated to drop 0.2 percent from the month prior, and possibly dragging the annualized rate to a 14-month low of 2.3 percent. There are downside risks to this reading as well, after producer import prices for the same period plunged 0.5 percent as moderate declines in the component sectors easily overwhelmed a 4.6 percent increase in crude costs. However, output prices actually held relatively steady, signaling that producers have yet to pass on weaker costs to consumers and creating the potential for softer CPI readings in coming months. Furthermore, fixed income markets have already start to curb bets on another rate hike by the Bank of England after multiple global central banks started a round of cash injections into financial markets in order to soothe a widespread credit crunch. Nevertheless, the BOE remains concerned that the five interest-rate increases that they?ve implemented in the past year may not be enough to bring inflation back to its 2 percent target as flood damage, foot-and-mouth disease, and faster economic growth threatens to stoke price gains. As a result, if CPI fails to fall back in line with expectations, traders could start to ramp up speculation once again that a hike looms on the horizon. On the other hand, if CPI weakens in line with or more than expectations, markets may start to forecast that interest rates have peaked at 5.75 percent.
[B]Bonds - 10-Year Long Gilt Futures
Gilts have dropped back down towards the trendline support, as bulls appear unable to continue the July rally through the 106.00 level. The choppy trade of the last two weeks may be preparing to extend, though a move to the downside may be more likely once equity turmoil washes out. However, traders should be aware of the hefty event risk associated with Tuesday?s CPI report, as a weak reading in line with or below expectations could propel Gilts up to the 106.00 level once again. On the other hand, if CPI proves to be stronger-than-estimated, the fixed income market may ramp up speculation of a September hike to 6.00 percent.

[B]10-Year Long Gilt Futures (Daily Chart)

The bid tone for the British pound appears to be lost from the currency markets as carry traders pare back exposure ahead of the consumer price index survey expected out tomorrow morning. Usually, the pair would likely be bid up through the announcement, however, given the global credit crunch from last week, nerves may be a little on edge. Furthermore, with expectations set for inflationary pressures to pare back in the UK economy, markets may start to consider the possibly that BOE policy makers will hold out until later in the year to raise rates to 6.0 percent, which could have the power to send Cable down to test the 100 SMA at 1.9997 and possibly even trendline support near 1.9950. On the other hand, a stronger-than-estimated CPI report could help keep Cable above 2.01. Either way Tuesday?s report will spell the British pound?s near term future until the release of the BOE?s August meeting minutes on Wednesday.
[B]GBP/USD (Daily Chart)

[B]Equities - FTSE 100 Index[/B]
Last Friday?s plunge in the FTSE 100 took aim on trendline support, and the massive losses just barely missed taking out the 6,000 level. However, Monday found the equity index surging higher, as global jitters regarding the credit crunch were soothed by an influx of liquidity injections by multiple central banks, including the European Central Bank, the Federal Reserve, and the Bank of Japan. Just as the markets have started to stabilize, though, the FTSE 100 faces major event risk from the UK CPI report. Inflation is expected to have eased in July, which would help to cool speculation that the Bank of England will hike rates in the near-term and could also give UK equities another boost to target the 200 SMA at 6,358. On the other hand, if equity traders are forced to contend with stronger-than-estimated CPI and the possibility of monetary policy tightening in September, the FTSE 100 may sell-off again towards 6,100.
[B]FTSE 100 Index (Daily Chart)

Written by Terri Belkas, Currency Analyst[/B]