Forex News – Sterling drops after UK inflation data

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CPI for the month of September rose 0.6 percent in the United Kingdom, marginally higher than the forecast rate of 0.4 percent on a monthly basis. Year-on-year, CPI rose 5.2 percent, beating estimates of a 4.9 increase, and higher than the previous 4.5 rise.

The British pound jumped at first after the data from 1.5753 to 1.5779 but soon dipped 70 pips to 1.5709.

Higher inflation rates are “usually” better for a currency but in this case it has a negative effect.

Usually, if a central bank tightens monetary policy to combat inflation, (i.e. increase interest rates) then this is positive for the currency.

However, the Bank of England recently announced policy easing in order to bolster the sluggish British economy, so this is negative for the pound. The key bank rate is currently at a record low 0.5 percent, as the Bank of England has kept rates unchanged for a while. UK 10-year bonds at yields are as low as 2.5 percent.

With further policy quantitative easing, interest rates will remain low and unattractive but inflation is high, and growth is lower but consumer prices are elevated, which impacts consumer spending.

The UK inflation rate is also being triggered to a large extent by increases in energy costs, and with no opportunity for “product substitution”, these elevated costs will transfer to consumer products and will therefore have an important direct impact in weakening consumer spending. The GDP growth outlook will, therefore, deteriorate further if inflation rises.

Sterling was already under pressure by the Bank of England’s decision to expand quantitative easing, which results in weakening the pound due to flooding the system with more of the currency.