The UK has just posted the consumer price inflation (CPI YoY – Jun) of headline 7.9% v 8.2% expected (prior 8.7%), core CPI was 6.9% v 7.1% expected (prior 7.1%). This is good news for UK investors. The UK stock market rallied on the day these numbers came out, with the FTSE 100 closing 1.8% higher than opening.
Part of the reason of the rally is the drop in the GBP strength thanks to the CPI numbers, meaning more foreign currency can be converted into GBP, boosting earnings for companies that receive their revenue in foreign currency.
The CPI fell to 7.9% primarily due to a significant drop in fuel prices. Despite this decrease, the inflation rate remains significantly above the Bank of England’s target of 2.0%. This recent inflation data has led to expectations that the Bank of England (BoE) will increase interest rates at a slower pace at its next meeting in August.
Financial markets predict a 65% chance that the BoE will raise rates by a quarter-point next month, from 5% to 5.25%. Despite having the highest inflation rate in the G7, the UK has seen the second largest rise in price levels since June 2019 among OECD advanced economies at 22%.
Policymakers are expected to maintain their hawkish policy stance for a while, with a 25 basis point rate hike likely at the August meeting. However, markets are now eyeing a peak in rates below 6%, which has weighed on the pound, now trading below the $1.30 level on the US dollar.
Don’t get too excited just yet
Even with a positive number read on the CPI, one measure of inflation, investors should not be jumping with joy. The alternative measures of inflation, like Truflation, still indicate that UK inflation is high. We can see the trend, the economy is cooling down, but for UK it is still quite far from the target of 2%. Unlike traditional methods that update monthly, Truflation updates its indexes daily, providing more current and comprehensive inflation measures.
Comparing the UK inflation the numbers with the US, we can see a more stable ‘cool down’ for the US economy, albeit with a strong labour market.
Dave Ramsden, Deputy Governor of BoE, Markets and Banking, gave a speech named “Quantitative Tightening (QT)” at the day UK released the CPI. However the stance of BoE is still unclear, and it emphasizes that the Bank’s QT policy will be contingent on economic conditions and will be implemented in a way that minimizes the risk of market disruption.
It is also crucial to cross check with the G7, with European countries performing better at reducing inflation. Investors should be cautious about participating in this turbulent market.
Now that we have looked at what is behind the stock market rally, in my next article on Monday I will look at what is really driving the indexes.