UK inflation expectations declined for a second straight month in July, with services inflation easing and wage growth stabilizing, reducing the likelihood of further aggressive Bank of England rate hikes despite turbulent oil markets.
The pound rose 0.4% against the dollar after the inflation data, as markets trimmed expectations for further BoE rate hikes. Lower inflation fears reduce the risk of economic downturn from overly tight policy, supporting the currency.
GBP/USD jumped from 1.2750 to 1.2850 within minutes, as traders interpreted the softer inflation as reducing the risk of a hard landing for the UK economy.
The short-term trend appears supportive, but much depends on upcoming UK retail sales and PMI data. If economic weakness becomes evident, the pound could reverse gains.
UK 10-year gilt yields dropped 8 basis points to 4.35% as the softer inflation report reduced the urgency for the BoE to keep rates high. Bond prices rose in response to the improved inflation outlook.
The rally was driven by a sharp decline in inflation expectations and a dovish repricing of the BoE rate path, with markets now expecting only one more rate hike this year instead of two.
Lower gilt yields reduce borrowing costs for the government, corporates, and households, supporting economic growth. They also make UK equities more attractive compared to bonds.
The FTSE 100 rose 0.6% on relief that the BoE may not need to hike as aggressively, which eases concerns about corporate borrowing costs and consumer spending. Exporters also benefit from a slightly weaker dollar.
Interest-rate sensitive sectors like homebuilders and real estate rallied, along with retailers, as lower rate expectations boost consumer spending potential.
That depends on whether the inflation cooling trend continues and global growth remains stable. Any sign of stagflation would likely reverse these gains.
Oil prices remain volatile due to supply concerns, but the article notes that UK inflation fears are easing despite this volatility, suggesting that oil's pass-through to broader inflation is limited at present.
Brent crude fluctuated between $82 and $88 per barrel amid supply concerns and demand uncertainties, but the overall trend did not significantly alter UK inflation expectations.
The Bank of England focuses on core and services inflation, which are less directly influenced by energy prices. Moreover, base effects and easing domestic price pressures are offsetting the oil volatility.
The stronger pound after the UK inflation data contributed to a modest decline in the dollar index, as the GBP component weighs on DXY. The dollar was already under pressure from slowing US inflation.
The pound's rally following softer UK inflation numbers weighed on the dollar index, as sterling has a significant weight in DXY.
Unlikely in isolation; DXY trends are primarily driven by US economic data and Fed policy, so the impact from UK data is typically short-lived.
UK inflation fears eased again in July as underlying price pressures showed signs of cooling, despite renewed volatility in crude oil markets. The decline in services inflation and stable wage growth reinforced expectations that the Bank of England can pause its aggressive tightening cycle, supporting UK assets. However, the uncertain oil supply outlook keeps medium-term inflation risks alive.
The July CPI report indicated a further deceleration in headline inflation to 6.8% year-over-year, down from 7.9% in June, with services inflation falling to 7.0% from 7.2%. Core inflation remained steady at 6.9%.
While oil prices have been volatile due to supply concerns, the underlying domestic inflation pressures in the UK are cooling, particularly in services and wages, which are more relevant to the Bank of England's policy decisions.
The softer inflation data reduces the urgency for further aggressive rate hikes, potentially allowing the BoE to pause or slow its tightening cycle, which had been one of the most aggressive among major central banks.