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U.S. dollar and British pound notes are seen in this November 7, 2016 picture illustration. REUTERS/Dado Ruvic/Illustration

MACRO VIEW COLUMNS: Sterling Is Looking Vulnerable Into Cautious BOE

(Bloomberg) — Sterling initially rallied in the wake of higher-than-expected August inflation data, but it’s now looking particularly vulnerable to a central bank that’s likely to “see through the data.”

  • Headline CPI in August rose 2.9% year-over-year, beating both the median forecast of 2.8% and the BOE’s projection of around 2.75%. Even core inflation jumped to 2.7%, its highest level since 2011
  • Policy makers need to decide whether this is a one-off or the start of a trend. At the MPC’s August meeting, the committee voted 6-2 to maintain the key rate at 0.25%. A hike isn’t a realistic outcome this time around — the issue in focus is just whether more members join the hawkish side
  • In June, BOE chief economist Andrew Haldane said the risks of leaving policy tightening too late are rising, and that he considered a vote for a rate increase as early as that month
  • The government’s announcement that it will ease the cap on public-sector pay rises may also spur hawkish rhetoric. But it should be noted that the increases for police and prison officers remain below inflation
  • Investors initially appeared to expect a more hawkish central bank statement as they pushed GBP/USD through resistance at 1.3267 and onto a 1.33 handle, a level last touched September 2016
  • However, stalling wage growth and uncertainty over Brexit talks will weigh heavily on the rate decision. Given the slow pace of Brexit negotiations, it could be many months before any clarity emerges on that front. Any delay in letting companies know what new rules they’ll be playing by is unlikely to be good for the economy
  • And let’s not forget sterling’s level. A hawkish sounding BOE could make it even stronger. While that may help to ease inflation, it’ll also weigh on growth. So the central bank will be wary of the currency overshooting
  • The balance of risks suggest that investors may have jumped the gun when buying sterling on the inflation data and that may be made clear today. That said, pound could be off to the races if the central bank does sound hawkish
  • NOTE: David Finnerty is an FX strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

To contact the reporter on this story: David Finnerty in Singapore at dfinnerty4@bloomberg.net To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net Nick Gentle, Mark Cudmore

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