Has inflation peaked? 

“The expected pickup didn’t happen. Inflation remains cooler and the pound dipped as investors had expected a rebound in July following the surprise drop in June. Inflation fell from 2.9% in May to 2.6% in June, where it remains. Month-on-month CPI declined 0.1% from June to July. Fuel exerted the biggest downward pressure month-on-month but core inflation, ex-fuel and food, was also steady at 2.4%.

Cable sank to the $1.291 handle, its weakest level in over a month, while the euro skipped past 91p to a little shy of the August 11th peaks. The data doesn’t radically alter the view on the Bank of England, but it certainly cements the belief that a rate hike this year now looks highly unlikely. The market was positioned for a bit more inflation than we’re getting.

CPI is still expected to peak at 3% later this year before easing back, yet there are signs that inflation may have already peaked. The sterling exchange rate has stabilised, meaning far less pass-through from the weaker pound on the inflation rate. We’re even getting to the stage in the year where the pound will be actually stronger than it was 12 months before, especially against the US dollar. Of course the pass-through from the exchange rate is a little more complex than that, but the broad picture is that the pound is pretty near to where it was last year.

If inflation has peaked, it would be good news for British workers, with wages still falling in real terms (confirmation of this trend is expected in tomorrow’s data). It would also be good news for the UK’s consumer-driven economy, which may ultimately be pound positive if it means resilient growth and the Bank thinks it can hike gently without upsetting wider economic confidence.”

Earlier sterling didn’t budge much at all despite signs we may be in for a smoother Brexit.

There was little to no uplift so far from the proposal for Britain to have a customs union with the EU for some years after the official Brexit date in 2019.

The market is treating anything from London with due caution, rightly so given the open splits in the cabinet and precarious tenure of Theresa May.

The real test comes when the third round of Brexit talks begin. If it flies with Michel Barnier and co it could be a lot more pound positive than we’re seeing now.  There are also doubts about whether this would be palatable for the Brexit camp in parliament and among voters if it involves compromises on the divorce bill and the free movement of people.

If you’re a pound bull this looks like a big step, and a signal that the softer transition side in government is winning the argument, but the sanguine response from the markets only highlights how far we have to go in the negotiation process.

 

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