Image © Giuseppe Milo, CC BY 2.0. Source.
The inflation report opens the door for the Dollar to further pressure the Pound.
The Pound to Dollar exchange rate (GBP/USD) resumed a short-term trend of weakness after the key monthly U.S. inflation report failed to shake FX markets from recent trends.
U.S. consumer price inflation rose 0.3% month-on-month in June, taking the headline year-on-year rate to 2.7%, with both headlines meeting expectations.
Ahead of the report, it was clear that a significant deviation from the expected inflation readings was required to snap the Dollar's ongoing near-term recovery.
Core inflation, arguably the most important figure for the FX market given it's what the Fed watches closely, landed at 0.2%.
Heading into the release there was an unusually wide consensus expectation for where the core figure would land, meaning anything from 0.2% to 0.3% was a realistic expectation.
"This is relevant because if you see 0.2 on core, be ready for a spike in bonds and quick reversal given that 0.2 is not really a surprise at all," says Brent Donnelly, analyst at Spectra Markets. "My conclusion is that neither 0.2 or 0.3 on either or both figures should be considered a surprise and I would expect mean reversion in bonds, FX, and stocks on either one."
This call was correct, with initial gyrations in the market soon yielding to the previous trend, ensuring GBP/USD stays pressured.
"GBP/USD has broken below important support zones (1.3630 and 1.3530–1.3550), now turned resistance. It is currently testing the 1.3434 level, aligned with a key trendline. A breakdown here could open the door to deeper losses toward 1.3370 and potentially the low 1.30s," says Fawad Razaqzada, analyst at City Index.
Image courtesy of City Index.
The important macroeconomic takeaways from the inflation release is that tariff headlines are yet to show up in any meaningful form, which lowers the odds of significant U.S. economic slowdown, something that is seen as negative for the Dollar.
With inflation settling above the Federal Reserve's 2.0% target, there is little reason for the central bank to cut interest rates anytime soon.
With a rate cut some time away, stock markets trading at new highs and limited negative impacts from tariffs showing up, it's little wonder the Dollar is finding its feet against.
At the same time, the British Pound risks slipping off its feet, with the economy disappointingly weak and the Bank of England sounding as though it stands ready to cut interest rates more aggressively.
With this week's inflation and employment data likely to reinforce the sense that the economy is misfiring, the near-term direction of travel for Sterling-Dollar will likely be to the downside.