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Faster UK inflation a tailwind for Sterling

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By Han Tan, Chief Market Analyst at Exinity Group

Asian stocks are following Wall Street’s positive lead, while European equity futures are inching higher Wednesday even as their US counterparts remain mixed.

Safe havens such as the US dollar and gold are holding on to Tuesday’s declines, as oil prices unwind some of the risk premiums surrounding the Russia-Ukraine geopolitical crisis.

The apparent de-escalation in the stand-off has resulted in the return of some risk appetite. However, investors and traders still have inflation concerns front and centre as the path towards normalisation of monetary policy continues.

The prospects of interest rates rising faster than anticipated should cap the upside for stock markets until markets get used to such an environment. Until then, markets have plenty of uncertainty to wade through, with further bouts of volatility likely in store.

UK inflation at 30-year high

The pound is climbing after higher-than-expected inflation in the UK stoked bets of even more aggressive rate rises from the Bank of England.

The UK’s January CPI rose 5.5% year-on-year, above the median estimate of 5.4%, which marks its fastest climb since March 1992. The core CPI, which strips out more volatile components such as food and energy costs, also came in at a fresh three-decade high of 4.4%, slightly higher than median forecasts.

With inflation pushing higher, the BoE may well have a strong case to trigger a 50 basis point hike at its March policy meeting.

At the early-February meeting, four of the nine members of the bank’s Monetary Policy Committee had voted for the unprecedented rate adjustment.

The scenario of a larger-than-usual hike was also given further credence by Tuesday’s UK data which showed another 108,000 jobs added in January to mark 14 consecutive months of job gains, along with a positive surprise in wage growth.

Overnight index swaps show that markets expect the UK’s benchmark rate to rise by another 150 basis points to reach 2% by November.

As markets continue pricing in such hawkish prospects, that could lead to more near-term gains for the pound.

Sterling is the only G10 currency that has advanced against the US dollar so far this year and could climb further if markets are led to believe that a 50bp hike next month is inevitable. Traders are currently pricing in a 60% chance of this happening.

With GBPUSD able to keep its head above the psychologically important 1.35 in recent sessions, Cable could make another run towards 1.37, barring another surge in dollar strength. The 200-day simple moving average and a key Fibonacci level combine here, to form the next challenge for bulls.

Fresh hawkish Fed clues

The incoming FOMC minutes and the scheduled Fed speak are set to hold large sway over how markets perform before the weekend.

Treasury yields and the US dollar could rise on further signs that Federal Reserve officials are ready to wield a larger interest rate rise hammer to quell soaring inflation.

However, such a narrative could erode US stocks’ week-to-date gains, while significantly capping any near-term upside until markets have fully digested the Fed’s path forward for US interest rates and the shrinking of its balance sheet.

For information, disclaimer and risk warning note, visit: https://exinity.com/en-ae

Exinity ME Ltd, a company registered under the Laws of the Abu Dhabi Global Market (ADGM), is authorised and regulated by the Financial Services Regulatory Authority (FSRA)