Following UK speedy recovery this year, many expects The Bank of England to hike rates sooner than US The Fed. However, yesterday's UK inflation report effectively diminished such expectations, as UK inflation rate dropped to its lowest in five years.

Following UK speedy recovery this year, many expects The Bank of England to hike rates sooner than US The Fed. However, yesterday's UK inflation report effectively diminished such expectations, as UK inflation rate dropped to its lowest in five years.

UK
UK Inflation Rate 2009-2014

Cooled Inflation, Cooler Expectation

UK Office for National Statistics (ONS) yesterday (14/10) reported that inflation in the United Kingdom fell to 1.2% yoy in September 2014 from 1.5% yoy in the previous period. This is worse than what economists expect, as Reuters poll predicted UK inflation to drop only to 1.4%. The significant slip means that consumer prices are falling in a hard way. The main drive is lower volatile good prices. The Wall Street Journal also mentioned that in the UK, there is a supermarket price-war under way. However, WSJ pointed out that core inflation also slowed. ONS report marked a distinct fall in UK September core inflation, to 1.5% from 1.9%. Core inflation record too, is at its lowest since 2009.


UKUK Core Inflation Rate 2009-2014

This is a particularly significant development to note, because low inflation means that the Bank of England will not be able to raise interest rates from the current record low of 0.5%. The main reason why interest rates in a certain country needs to be hiked is that prices in the country has risen considerably fast during a certain period. To control such inflation, central bank have to tighten monetary measures by raising rates. If inflation growth is no more, then so do interest rates hike.

Back in June, Bank of England governor, Mark Carney, said that they might hike rate sooner in accordance with job market recovery. Analysts then expected BOE rate hike to happen in November 2014 at the soonest, and early next year at the latest. But in August, Carney backtracked, suggested that interest rates might not be hiked till next year because of slow wages growth. Consequently, market lose confidence in the wake of Scotland independence referendum and subsequent blooming sentiment on the Fed rate hike. Therefore, this latest inflation report effectively shut down expectation that BOE will raise rate sooner than the Fed, as investors move back BOE rate hike expectation to November 2015, while the Fed's that was put forward to the second quarter of 2015.

Long Way To Full-Employment

UK economy moved fast in the first half of 2014, recorded 2.7%, 2.9%, and 3.2% annual growth rate in the first, second, and third quarter respectively. Unemployment too, has dropped to its lowest in post-crisis era. For a while, inflation was also secured around 1.5-1.9% during January-August 2014. But it seems that various factors have pushed inflation down, while wages stagnates and GDP is expected to moderate in the fourth quarter.

Eurozone slowdown has dragged along UK manufacture sector. UK Manufacturing PMI recorded third consecutive drop early this month, slipped to 51.6 in September from 52.2 in August. Previously, it was at seven months high (57.5) in June, but fell to 54.8 in July. The longer Eurozone slowdown goes on, the worse it will be for countries that closely relate to it, particularly those in the European Union like the UK.

These circumstances weighed Poundsterling down. By the time this editorial was written, GBPUSD has dropped to its year-long low level and being traded under 1.60, the previous key support. The next make-or-break event is ONS report on UK job market that will be released later today. Beside of reporting the number of unemployment benefits claimant and UK unemployment rate, the publication includes average earnings data that has become a new high-impact fundamental after Carney told people that BOE is concerned about wage stagnation.

In August, UK have recorded improved unemployment rate from 6.4% to 6.2% and dropped Claimant Count Change from -37.4k to -37.2k. For the month of September, forecast expect the number of unemployed in the UK to drop again up to -35k, and unemployment rate to dip into 6.1%. Predicting average earnings is more difficult, but it is expected to go up as well. If these happen, then it could revive market confidence on BOE rate hike, and bring the Poundsterling up along with it. It is already quite impossible for BOE to raise rates before the end of this year, but there are still chance that BOE rate hike could occur in the first half of 2015 if job market is well. The reason is, better job market encourages consumer confidence and domestic spending that might drive inflation either up or down.

However, if UK job market slip from expectation, then it will open opportunity to sell the Cable for a bit longer. BOE have cautioned that Eurozone slowdown might have wider influence in the UK, and worse-off unemployment might be the first indication of such negative influence. For advanced countries on the road to recovery like the US and the UK, low inflation and stale unemployment are real threat in attaining sustainable growth.

Pounds Technical Valuation

Poundsterling has dropped about 1% against US Dollar this week, and continue to move under mid and long term moving averages. Key support for the next GBPUSD movements this week is 1.5876 that was touched this morning. There is little chance for GBPUSD to move out from under 1.60, but if employment report is well, then it will give GBP some leverage ahead of US retail sales data release.


GBPUSDGBPUSD In H1 Chart With EMA-200 (magenta), EMA-60 (blue), EMA-20 (red), Fibonacci Retracement, and MACD

However, be aware that Poundsterling failure to secure its place will make it vulnerable to further better-than-expected fundamental data that might come out from the US in the rest of the week. Therefore, watch 1.5876-1.6012 closely to look for hints and confirmation for the next price movements.