U.K. Inflation: Still Not Good Enough?

Aha! Looking at the most recent inflation data, it seems that prices in the U.K. are flyin’ higher like Taio Cruz! Does this mean the pound is set skyrocket on the charts too, or will U.K. inflation be included in the “High Expectations Asian Father” meme because it’s still not good enough?

Before we answer that question, let’s first do a quick review of the PPI report for January.

According to National Statistics U.K., prices of raw materials used by manufacturers increased by 1.7% during the month and overshot the 1.3% uptick that markets were expecting. In addition to that, the input prices report for December was revised up to 3.9% after being initially reported at 3.4%. Meanwhile, output prices came in more than double the 0.4% forecast at 1.0%. Consequently, this increase pushed annual inflation up to 4.8%.

If you’re scratching your head wondering about what drove prices higher, then scratch no more! I dug a little deeper into the report and I discovered that it was the surge in food and gas prices.

Because businesses usually pass on additional costs to consumers, a lot of economic gurus are expecting the CPI report for the same month to overshoot both market expectations and the BOE‘s target range of 1.0% to 3.0%.

If you’ve been reading the best forex education site in the hood, then you most probably know that currencies usually rally on strong inflation numbers. But strangely enough, the pound didn’t rally at the wake of the positive PPI report. In fact, according to Pip Diddy, it fell by about a hundred pips!

Fast-rising prices usually signal strong economic growth, but could also hurt consumer spending and investment if left untamed. This is why central banks usually hike their interest rates -so companies can cool down from too much borrowing and investment spending. Consequently, higher interest rates also means better carry trade yields, so currency bulls charge at even the slightest rumors of cash rate hikes.

In the BOE’s case though, the decision whether to raise rates or not is a lot harder than it seems. Even though the MPC hawk Andrew Sentance recently found a bro in Martin Weale in supporting a rate hike, many MPC members are still worried that higher interest rates could add to the weight of the heavy austerity measures already hitting the U.K. economy. On the other hand, spending and economic growth problems could escalate if the BOE policymakers keep sitting on their hands.

So does this mean the pound bulls’ strange reaction to the PPI report will be mirrored in the CPI report which is due today at 9:30 am GMT?

Before you start dumping the pound, it might be better to wait for the upcoming BOE Inflation Report to be released. Who knows if the central bank officials still have a few tricks up their sleeves and be able to convince the public that they can keep inflation contained even without hiking rates?

Besides, the BOE could put a positive spin on the recent inflation figures and point out that these could lead to better growth prospects for their economy. Aside from that, they are expected to reiterate their view that excess capacity could exert downward pressures on price levels and could eventually restore annual inflation back to their comfort zone in the next few months.

Still, the pound’s movement would largely depend on whether market participants believe in the BOE or not. Some economic gurus believe that the slack in the British economy is smaller than expected, which means that it probably wouldn’t have a significant drag on price levels. If that’s the case, the central bank better act quick before it’s too late!