Higher Inflation Raises Questions for the Bank of England and Rishi Sunak in Election Year

Sterling stronger as Inflation fails to fall as fast as expected

The pound rose yesterday as UK inflation came in higher than expected. This caused the pound to rise because it made it less likely the Bank of England would cut interest rates as quickly as expected.

The data showed 4% inflation for the year to December, with cigarettes and alcohol the culprits for rising costs. These factors are being mooted as temporary, or more of a blip, since other inflationary indicators suggest a fall.

The overall trend since a peak of 11% shows the headline inflation rate has been falling, which continues the baseline expectations and case for interest rate cuts at some point this year. The vital question for the FX markets is when will the cuts take place.

The next Bank of England decision is two weeks today, when the MPC (Monetary Policy Committee) will meet to set policy, after discussing the economic outlook for the UK. They may also undoubtedly (whether intentionally or not), lay the foundations for market expectations on interest rate cuts.

Higher inflation means interest rates might need to remain higher for longer. However, the fact yesterday’s is being seen as more of a blip, rather than the beginning of a new trend higher, does take some of the bluster out of the release.

Nevertheless, the pound remains elevated on the news, and it means the Inflation story for the UK remains uncertain, and likely to be as closely watched as ever.

Will Rishi Sunak’s position become even more untenable and how will this affect the pound?

In this election year, the current UK Prime Minister Rishi Sunak, and Chancellor Jeremy Hunt have promised to get inflation back under control. Rishi also promised to ‘stop the boats’, and these are two areas where the government is seeking to establish credibility.

The rising inflation news is therefore bad, as cost of living worries in the UK are an easy target against the government. Labour is seriously outperforming the Conservatives in the polls, and expectations are for a Labour win.

The UK election is in the autumn, with dates to be confirmed. Elections are typically very volatile times for a currency, and sterling has plenty of historical turbulence around the periods of UK General Elections.

Whilst Labour appear likely to win, markets are not totally agreed on how this will influence sterling. In the past, a Labour win might have seen the pound weaker. Now, some commentators see this being a strength.

Sterling could therefore be in for a busier period in the months and weeks ahead, as markets try to second-guess what this result will actually mean for the UK. And all of this will happen, whilst we might be awaiting news on interest rate cuts. How might all of this change investors’ attitudes to the UK and sterling?

2024 is shaping up to be a crucial year for FX markets, with elections in the US as well, and the prospect of interest rate cuts from the US and also in the Eurozone.

For a more detailed discussion of the FX outlook, and all of the factors driving the currency markets, please contact one of our expert team.

We will be very happy to share market insight and outline strategies to manage your exposure to the ever changing and volatile world of foreign exchange.

Jonathan

jonathan.watson@lumonpay.com