Market Wrap: Pound Strengthens As CPI Rises, U.S. CPI Remains Unchanged

Globally equities declined on Tuesday following U.K. CPI that accelerated faster than expected. This is the first hard data to be released following the June 23rd decision to leave the EU with actual readings (YoY Jul) coming in at 0.6% against estimates to remain unchanged at 0.5% as a significantly weaker Pound increased input costs. A measure of Core CPI which excludes some more volatile items was slightly less than forecast, up 1.3% vs forecasts of a 1.4% gain. Tonight’s U.K. unemployment figures out at 6:30pm Sydney time will give us further insight with forecast for the rate to remain stable at 4.9% with BoE forecasts expecting this number to rise slightly next year.

The GBP/USD strengthened 1.26% against the U.S. dollar, shown on the first chart below, and +0.44% against the EUR/USD as both the FTSE100 & FTSE250 declined -0.68% & -0.67%. This higher than expected reading seems to have caught the market by surprise and may cause some to adjust their interest rate expectations as this data would suggest the potential to reach the Bank of England’s target inflation rate faster than expected. While this certainly seems likely given the 13% fall in the Pound recently, increasing input costs we have seen the BoE signal its willingness to look through higher inflation over the medium term in order to offset any potential negative shocks to the economy following the Brexit. Therefore we can still reasonably expect that the BoE will look to ease monetary policy again later this year which should limit too much upside in the Pound.

Broader European equity markets were also lower on Tuesday with the Euro Stoxx 600 declining -0.79% as did the DAX -0.58% with the Euro strengthening +0.82% against the U.S. dollar. Data out of mainland Europe saw an improvement in the ZEW economic sentiment survey for August which increased to 4.6 from -14.7 in July.

U.S. equities also pulled back from record highs on Monday with the S&P 500 & Nasdaq 100 both slipping -0.55% & -0.62% respectively as the USD fell against major trading partners with the U.S. dollar index down -0.87%. Data from the U.S. showed that housing starts (MoM Jul) increased 2.1% against expectations of a -0.8% decline while building permits (MoM Jul) declined -0.1% vs 0.6% estimates as we continue to see relatively healthy strength in the U.S. housing market.

U.S. CPI (MoM Jul) was unchanged from June as forecast while missing estimates of a 0.9% increase from a year earlier with an actual reading of +0.8%. CPI excluding the more volatile items of food & energy increased 2.2% vs 2.3% (YoY Jul). Real average weekly earnings (YoY Jul) increased modestly from 1.2% to 1.4%, while both industrial & manufacturing production (MoM Jul) increased 0.7% & 0.5% more than the forecasts of 0.2%.

The USD remained weak overnight despite comments from two Federal Reserve Presidents that the market was underestimating the likelihood of a rate hike later this year. New York Fed President William Dudley stated that “We’re edging closer towards the point in time where it will be appropriate, I think, to raise interest rates further” noting he believes the labour market will continue to tighten with growth picking up in the second half of the year. At the same time non-voting member Dennis Lockhart of the Atlanta Fed suggested “If the meeting were today, I think the economic data stream would justify a serious discussion of a rate increase,” although noting the inflation outlook has not changed much. FOMC memebers will certainly be aware the market has been pushing back rate hike expectations driving both equities & bonds higher and these comments could simply be an effort to talk down the pace of activity.

We have the FOMC minutes from the July 26-27th meeting out at 4am Sydney time on Thursday and the market will no doubt be pouring over these looking for further clues as to when we may see a second rate hike. At the end of this month we also have PCE inflation numbers, the Fed’s preferred measurement, and this will give us further insight. Overall the situation has not really changed much, the U.S. economy continues to do OK but not enough to justify a second hike yet. There are signs of a healthy labour market following two months of strong payroll data and some firming of wage growth highlighted by the Atlanta Fed wage tracker. However business investment and productivity remains weak and with an ageing population and declining participation rate this will be key to increasing economic growth. Until this time inflation is likely to remain fairly subdued and it makes sense for the Fed to err on the side of caution when it comes to raising borrowing costs.

The weaker U.S. dollar helped pushed the USDJPY back below 100 on an intra-day basis for the first time since the Brexit, shown on the second chart below, with the strong Yen driving equities lower in Japan with both the Nikkei & Topix indexes down -1.62% & -1.38%.

Locally the S&P/ASX 200 declined -0.14% as the Australia dollar gained +0.30% meanwhile the market is set for a modestly weaker open this morning with ASX SPI200 futures down 6 points in overnight trading. On Tuesday we had the release of the minutes from the Reserve Bank of Australia’s August meeting where it decided to lower interest rate by 25 basis points to a record low 1.5%. The minutes contain much of what we expect, growth remains around or modestly above potential while labour market conditions continue to improve.

Despite highly accommodative monetary policy, both globally and domestically, inflation remains subdued and is expected to remain low for some time. Noting that “prospects for growth were positive, there was room for stronger growth, which could be assisted by lower interest rates” following evidence that risks associated with rising household leverage had diminished, leaving the door open for further easing in the coming months.

Upcoming data releases:

• Australian Westpac Leading Index (MoM Jul) 10:30am AEST
• Australian Wage Cost Index (YoY Q2) 11:30am AEST
• U.K. Unemployment (MoM Jul) 6:30pm AEST
• U.S. Crude Oil Inventories (Aug 12) 12:30am AEST
• U.S. FOMC Meeting Minutes (Jul 26-27th) 4:00am AEST

This article was written by James Woods - Global Investment Analyst, Rivkin Securities Pty Ltd. Enquiries can be made via james.woods@rivkin.com.au or by phoning +612 8302 3600.

Chart 1 – GBP/USD, Chart 2 – USD/JPY