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The Pound enjoys its strongest day for nearly two weeks

Published: 16 Jul at 9 PM Tags: Pound Sterling, Euro Exchange Rate, Dollar Exchange Rate, Currency Exchange, Euro Crisis, UK, Economy, Inflation,

The Pound enjoyed its strongest day in the currency markets for nearly 2 weeks yesterday after the Office for National Statistics (ONS) reported that the UK inflation rate rose at a faster pace than had been anticipated and is now just below the Bank of England’s (BoE) set target of 2%.

The ONS data shows that the consumer price index (CPI) rose to 1.9% in the 12 months to June 2014, sharply up from the 1.5% figure recorded in May. The data showed that the rise was driven by clothing, food, non-alcoholic drinks and the air transport sectors.

Samuel Tombs, UK Economist at Capital Economics commented that "However, the rise in clothing inflation from -0.1% in May to 2.4% seems to have largely reflected the later start to the summer sales this year than last, so its annual inflation rate should ease soon. In addition, a further significant rise in food inflation from June’s 0% rate seems unlikely, given that global agricultural commodity prices have fallen in recent months and a price war between the supermarkets appears to be building. As a result, we maintain our long-standing forecast that CPI inflation could ease to about 1% by the end of this year and remain below the 2% target in 2015. Not only would this enable real earnings to finally stage a recovery, but it should also give the Monetary Policy Committee scope to raise interest rates only gradually next year."

For his part, Chris Williamson of Markit said that the lack of wage growth remained a strong argument for the BoE to continue to hold UK interest rates at the record low rate of 0.5% that rates have now been stuck on since March 2009 as long as inflation also remains well below the 2% target set by the BoE. Williamson said "Our expectation, however, is that wages growth is picking up, and that more MPC members will consequently join the call for a tightening of policy in coming months, with the first rise in interest rates most likely coming in November."

The rise in speculation about the BoE’s intentions and England's early exit from the Football World Cup were two factors blamed by the British Retail Consortium (BRC) and accountants KPMG for the latest data which showed the lowest growth in UK total retail sales last month since May 2011 with total sales rising by just 0.6% in June against a 2.9% gain made in June 2013. On a like for like basis, UK retail sales fell by 0.8% for the 12 months to June 2014 whereas they had increased by 1.4% in the previous 12 months.

David McCorquodale, Head of Retail at KPMG, said "June saw the brakes applied to spending as shoppers put purchases of big ticket items on hold whilst they waited to see if the Bank of England would take action on interest rates. Even sales of home accessories and furniture flat-lined, which is surprising given the UK is reportedly in the midst of a housing boom. Sales in the food sector also struggled, with England's early exit from the World Cup exacerbating the grocers’ problems."

Meanwhile, BRC Director-General Helen Dickinson said "Consumers continue to benefit from competitive pricing, which may be the cause of softer like-for-like sales in June. The recovery is still on track, but we're detecting differences in attitudes from customers, perhaps led by the competitive environment for food prices. Consumers are delighted to be saving on their food bills, but are prepared to spend a little bit more on discretionary items."

Finally on the UK, BoE Governor Mark Carney reported to the Treasury Select Committee yesterday and again highlighted concerns about accelerating house prices in the UK pointing out that UK house prices are now an average of nine times’ of an average salary and pointed out that in his opinion, rising house prices are the direct result of personal indebtedness on the banking system.

Carney confirmed that the BoE is undergoing a stress test based on a worst case scenario of a 35% drop in house prices, plummeting employment levels and a three-year recession.

On the hotly debated subject of UK interest rates, Carney said “We don't know exactly when the rate cycle is going to start. It will be driven by the data, we do expect markets to react to that data. We were concerned that markets were not reacting to data, a fairly long run of data, that was as good as expected, if not slightly better. We had no pre-set path, the only guidance that the new MPC is now giving is around the expected medium-term path of interest rates, not the timing of the first rate rise."

The pound benefited across the board, rising strongly in the foreign exchange market against all 16 of the most actively traded currencies in the market.

Across the channel, the respected ZEW institute reported that German economic confidence fell at a sharper rate than expected in July adding to recent indications of a slowdown in Europe's strongest economy.

Analysts commented that "We anticipate growth of around 2% this year and next, which will not be enough to generate a significant revival in the rest of the single currency area or to eliminate deflation risks".

Across the pond, Federal Reserve Chair Janet Yellen in her latest testimony to the Senate Banking Committee signalled yesterday that US interest rates will remain low for some time since the US economic recovery is "not yet complete" and too many Americans remain unemployed.

In a she said the central bank must continue with monetary stimulus due to weakness in the labour market and inflation.

In June, the Fed scaled back monthly asset purchases by a further $10 billion and agreed to end the programme in October provided the US economy continues to improve.

Yellen signalled today that US interest rates are likely to remain low for a considerable period after the monthly asset purchase program ends.