UK inflation fails to disappoint the bears

Investor attraction towards the GBP just declined even further. The GBPUSD fell to a weekly low (1.5077) following UK inflation levels for December being confirmed at an annualised 0.5%, its lowest level since May 2000. Heading into Tuesday’s trading, the major downside risk for the Sterling was that UK inflation levels would be announced below an annualised 1%. However, very few thought UK inflation levels would drop this low as quickly as they did, with this inevitably further strengthening the Bank of England’s (BoE) already dovish views on inflation, and further delaying expectations for the BoE to begin raising UK interest rates.

What the inflation readings really do is create anxiety over what could happen with the readings next month, because there is still no floor in sight in the oil markets and this means prices are further declining. Although this would have been unbelievable to think about six months ago, the UK could really be staring at a deflation threat with some economists already warning that February’s inflation data could provide a 0.2% annualised reading. An awareness that the BoE possesses very strong views on inflation was already weighing on the currency and limiting investor attraction, however these views would have now strengthened significantly further. Not only this, but investor attraction had already weakened by factors such as an upcoming UK General Election and repeated signs of some loss in domestic economic momentum.

Although a potential deflation scenario would alert traders, the risks the GBPUSD face are different to those of the EURUSD. For example, the BoE have previously stressed that there will be no further easing of monetary policy from the central bank, and I continue to expect them to stress this message. This on its own is quite a contrast to the risks for the EURUSD, with the ECB seemingly prepared to increase stimulus. Easing monetary policy at the wrong time would potentially threaten a currency, however the BoE previously stressing this will not be the case will in some ways limit possible GBP losses.

Furthermore, the UK and EU economic situation is far different. For example, the EU economy is caught in what appears to be stagnation with high unemployment and marginal economic growth; whereas the UK economy remains the most developed growing economy in the advanced world, with its unemployment numbers continually narrowing. The decline in inflation is still very positive for consumers, with household budgets being eased for families who have long suffered with low disposable incomes. Improved consumer sentiment should also lead to improved consumer spending at a time of the year when retailers usually suffer with lower sales. Other than the decline in UK inflation, the other market headlines have continued to focus on the suffering in oil prices, which continues with a new low for Brent being recorded at $46.38 and Crude at $44.17. Factors such as 2015 forecasts being lowered and reports of there being an oversupply of around 1.8 million barrels of oil in the markets are just further tipping the scales of the already overpowering supply and demand equation in favour of the bears. With global economic health remaining a hot topic and these same concerns likely going to lead to less demand for the commodity, we are still some distance away from finding a floor in the oil markets.

Written by Jameel Ahmad, Chief Market Analyst at FXTM.

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