Sterling has strengthened against its peers this morning following the highly anticipated UK inflation report. While the headline figure matched the Bank of England’s (BoE) 2% target for the first time in nearly three years, persistent services inflation remains nearly double its 2000-2019 average, likely postponing the BoE's first interest rate cut until August. Before the inflation report, markets saw less than a 50% chance of a rate cut; now, the probability stands at 43.3%.
Services inflation, a key measure of inflation persistence identified by the Monetary Policy Committee (MPC), was significantly higher than the BoE expected last month, quashing hopes for a rate cut at the BoE’s meeting tomorrow. This month, services inflation has remained stubbornly high, slowing to 5.7% but still exceeding the 5.5% estimate. Another critical metric for the BoE is private sector wage growth, which continued to slow in April despite a substantial increase in the national living wage that month. Assuming supportive incoming data, we anticipate the MPC will reduce the Bank Rate by 25 basis points in August and November, though next month’s general election introduces an element of uncertainty, given the limited scope for fiscal policy adjustments.
Opinion polls indicate that the opposition Labour Party is poised to win the general election on July 4 with a significant majority. This is considered the best-case scenario for the pound. However, in the short term, a dovish BoE could have a greater influence on sterling, making the currency vulnerable, especially since it appears overvalued against the euro based on interest rate differentials.
