Inflation up at 2.9% and Traders are Bullish on the Sterling
Britons are faced with a catch 22: On the one hand, inflation is rising rapidly, and this bodes well for an increased interest rate and an appreciating GBP. On the other hand, rising inflation means that Britons are being squeezed more than ever before. With falling real wages and rising prices, the cost of a basket of goods and services is rising rapidly. In August 2017, the inflation rate in Britain spiked 0.3% to hit 2.9%. That is the equivalent of the 4-year high inflation rate reached in May 2017. Unfortunately, wages in the UK are only rising by 2.1%, meaning that the purchasing power of the GBP is declining by 0.8% overall.
However, steadily increasing inflation will need to be addressed by the Bank of England. The way the BOE and Governor Mark Carney will deal with this is clear: Raise the bank rate at the next meeting of the BOE Monetary Policy Committee. The rising inflation rate means that the cost of everyday items such as petrol, menswear, womenswear, food and the like are now relatively more expensive. Ironically, it is the weak GBP which is responsible for rising prices on all imported goods and services. As is so often the case when major economic announcements such as inflation rates are made, the GBP reacts almost immediately.
At the time of writing on Wednesday, 13 September 2017, the GBP/EUR exchange rate was 1.11061. The currency pair has a 52-week range of 1.106 on the low end and 1.1131 on the high-end. Simply put, this means that £1 is the equivalent of €1.1108, and it is moving away from parity. This indicates a strengthening of the British pound. Much the same is true of the cable. The GBP/USD currency pair is now holding firmly above the critical 1.300 level and is trading at 1.3202. This remarkable turnaround from the 32-year low recorded after the Brexit referendum on June 23, 2016 is significant. Already, rising inflation has been priced in to the exchange rates as speculators expect the Bank of England to move quickly on interest rates.
What does the Bank of England think about rising interest rates?
Clearly, one of two conditions for a rate hike has already been met by the Bank of England. The BOE has long been targeting an inflation rate of 2%, and now that figure is being exceeded month on month. This will invariably result in a decision on a rate hike sooner, rather than later. Now that the GBP is sitting at a 1-month high against the EUR, speculators are anticipating a BOE rate hike. The UK is ripe for a rate hike from the historic low of 0.25%. Bank of England Governor, Mark Carney is likely to pull the trigger on the first rate hike in several years, with a 25 basis point upward revision. This will raise the bank rate to 0.50%.
Naturally, the GBP will strengthen when interest rates rise. This will result in more traders flocking to buy the GBP with net long positions, while selling other currencies like the EUR, JPY and USD. Several hawks are currently sitting on the MPC, including Michael Saunders, Andy Haldane, and Ian McCafferty. If economists are correct, BOE Governor Mark Carney may also switch sides and push for a rate increase. Fuelling talk of a rate hike is the 2.9% August inflation rate. It is generally expected that rising interest rates will strengthen the GBP and slow down price increases. That unemployment is at a multi-decade low also indicates that now is the time for the BOE to pull the trigger on interest rates.
What is your opinion of an interest rate increase in the United Kingdom? Do you think that Mark Carney should raise interest rates, or should we wait and see how Brexit negotiations go before jumping to conclusions?
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About Brett Chatz
Brett Chatz is a graduate of the University of South Africa, and holds a Bachelor of Commerce degree, with Economics and Strategic management as his major subjects. Nowadays Brett contributes from his vast expertise in online trading for iForexTrader.co.uk.