Published: 15/02/2023 By ECAPThis week is a hectic one for sterling, with a host of UK data releases creating a volatile trading environment. Yesterday's UK labour report was on the strong side. Earnings growth excluding bonuses jumped by 6.7% in the three months to December, unemployment remained near multi-decade lows, while the claimant count number, which measures the number of jobless benefit claims, dropped by 12.9k - the most since July. Data released last week showed that the UK economy avoided tipping into recession in the final quarter of last year, and the strength of the labour market could help to prevent one in 2023. The key to the above will, however, likely be the persistence of UK inflationary pressures.
This morning’s January inflation data eased more than expected, which is positive for the growth outlook, but not so for sterling. Headline prices fell by 0.6% on the month, the largest drop since January 2019, with the annual rate easing to 10.1%, versus the 10.3% priced in. The sharp decline in core inflation will also be a welcome one - this fell to 5.8%, its lowest level since June. Sterling has come off around half a percent on the dollar on the news. While this should lessen the risk of a deep and prolonged recession, it may also take pressure off the Bank of England to continue raising rates aggressively. Markets now see just two more 25bp hikes from the MPC this year, with a 50/50 chance of a first rate cut by year end.
Euro zone inflation could fall faster than earlier thought given a host of positive developments in recent months. However, past rate hikes and a tight labour market could still exert upward pressure on underlying prices in the near term. Nevertheless, recent data on euro area inflation and some of its key determinants are somewhat encouraging, but the overall situation still requires caution. Having raised rates by 3 percentage points since July, policymakers have started to ponder when and where the fastest tightening cycle in ECB history will end, especially since inflation is now retreating quickly from record highs. Ultimately, Lagarde stated last month that the ECB will keep raising interest rates quickly to slow inflation which remained far too high, and traders will be looking to see whether she has toned down this sentiment during her press conference later today.
The dollar climbed higher in early European trade this morning after U.S. consumer inflation remained elevated in January. The Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.3% higher at 103.46. Headline U.S. consumer inflation came in at 6.4% year-on-year for January, higher than the 6.2% economists had expected, while the widely-watched year-on-year core figure, which takes out volatile items like energy and food, came in at 5.6%, ahead of the predicted 5.5%. These figures suggest that inflation is proving difficult to tame, even after a series of interest rate hikes, opening up the likelihood that the Federal Reserve will see a higher end point for these increases than the market had originally envisioned. Looking forward, U.S. retail sales figures are due later in the session and will provide clues as to how the U.S. consumer is bearing up after the series of Fed rate hikes in the past year.