Sterling jumped against the euro and dollar after UK inflation beat expectations

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The pound-to-euro exchange rate hit its highest level since March at 1.1736 after UK inflation fell to 2.3% year-on-year in April, a figure that was higher than market and Bank of England expectations of England (2.1%).

The all-important and much-watched services inflation component of the announcement was significantly hotter than expected at 5.9%, while the market and the Bank of England were expecting a reading of 5.5%.

The odds of a June rate cut at the Bank of England are now well below 50%, having been close to 60% just days earlier. The rise in the value of the pound reflects this adjustment in Bank of England policy expectations.

The pound rose against all its G10 peers after the announcement, with the pound-to-dollar exchange rate hitting 1.2745, its highest level since March 21. “The market reacted to the news. Sterling rose against the dollar to a high of $1.2759, from $1.2707 before pulling back to $1.2735, now markets don’t have a full discount until November, from the previous August,” said Gabriela Dickens, G7 economist at AXA Investment Managers.

Those who read the recent Pound Sterling Live article reflecting the views of Andrew Sentance, which warned of an upside shock, will be prepared for a possible upside surprise. “My forecast for core inflation and service inflation was broadly correct. I forecast core inflation at 3.8% – the actual figure was 3.9%. My forecast for services was 6% vs. 5.9% actual. Core inflation measures came in much higher than market consensus,” Sentance said after the release.

The result, meanwhile, eases the tail risk for the pound from a string of successive interest rate cuts over the summer. “Does the central bank cut in June, or does it take advantage of the fact that inflation is slightly higher than expected and hold off until its August meeting?” The movements in the currency markets this morning suggest that a cut in August has just become a little more likely,” said Nicholas Hyett, investment manager at Wealth Club.

“UK inflation of 2.3% is now below the G20 average – where it will remain for the rest of the summer – but the token of being above 2% will delay some of the sharper policy calls for cuts by a month or two says Simon French, economist at Panmure Gordon.

Above: GBP hit fresh multi-week highs against the dollar and euro. Track GBP/AUD with your own custom rate alerts. Set up here

He explained that services inflation of 5.9% was the most significant aspect of the report as it proved that non-tradable components were proving more volatile than expected. “We’ll stick to August for the first rate cut – although another round of wage and price data will come before the MPC in June,” French says.

“Today’s release was a bit of a blow for the BoE and the Prime Minister,” said Paul Dales, chief UK economist at Capital Economics. “While there is still a release of wages and CPI ahead of the BoE meeting on June 20, a cut now looks very unlikely. Even a cut in August looks a bit more dubious.”

In detail, the drop in household energy bills in April provided the most significant downward impulse to inflation. Falling food prices also weighed. There is also a noticeable drop in inflation for clothing and footwear and alcoholic beverages.

Image courtesy of BRC.

As the chart above shows, service-oriented industries such as restaurants and hotels continue to raise prices. This will reflect the high wage costs faced by these industries and underlines that inflation will only return to the 2.0% target on a sustained basis if wages cool.

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