Sterling retreats in the face of red-hot inflation

LONDON: The pound retreated on Thursday after data showed British inflation is proving far more persistent than expected and is far higher than anywhere else in Western Europe, underscoring the threat to an already fragile economy.

Headline inflation fell to 10.1% in March from February’s 10.4%, but it was well above expectations for a fall to 9.8%, data showed on Wednesday.

More worryingly, the details in the report from the Office for National Statistics showed price pressures are everywhere and cannot be easily explained away by the sharp rise in the cost of energy over the last couple of years.

The pound was last flat against the dollar at $1.244, and down 0.1% against the euro at 88.19 pence.

Sterling is the second-best performing currency in the G10 against the dollar so far this year, with a gain of 2.67%, just behind the Swiss franc, which has gained 3% in that time.

The prospect of the Bank of England having to raise rates more than previously expected has partly driven flows into sterling, but that boost might not last much longer, given the impact of high prices on households and businesses.

“The type of inflation the UK has now — linked to an energy crisis, labour shortages, and a term of trade shock — is never good for a currency. It’s an erosion of internal purchasing power.

Sterling edges back from 10-month peak

Simply look at real wage growth,“ Stephen Gallo, who is global currency strategist at BMO Capital Markets. Real wages in Britain, earnings adjusted for inflation, showed one of the biggest drops on record in the three months to February, with a fall of 4.1% year on year.

Grocery inflation is running at a record 17.5%, according to industry data, with staples such as milk, cheese and eggs rising the fastest. Money markets show traders believe the BoE will raise rates to a peak of about 5% by November this year, from 4.25% right now. A month ago, that expectation was for a peak at 4.00%.

“You probably don’t want to be buying sterling if core inflation remains stubborn above 5% after three more 25 bps rate hikes from the BoE, which is currently priced into (overnight index swaps),” Gallo said.

“Flip side, if the Q2 data reveal a meaningful drop in price pressures, there is probably a stronger case for sterling to avoid an isolated decline. My base case is the second scenario, but I am more worried about the first,” he said.