This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
Summary
- This week’s UK inflation data was weaker than expected, with headline and core at the lowest levels since 2021.
- This has weighed on UK yields and GBP and increased the probability of two 25bp BoE rate cuts in November and December.
Market Implications
- We expect further downside for UK yields and GBP.
- We like buying price dips in gilts and fading GBP bounces (both of which have been seen post UK retail sales today).
Inflation Data Surprised (Everybody) to the Downside
The UK’s September CPI data really took markets by surprise, judging by the reaction in the gilts and FX market. Headline CPI, both on a MoM and YoY basis, came in below consensus expectations, as did the YoY core and YoY services readings.
Moreover, and perhaps more importantly, the headline YoY CPI reading, at 1.7%, undershot the BoE’s forecast from the August MPR.
UK Yields Are Off Their Recent Peaks
The weak data pushed UK yields lower this week across the curve. The 2-year gilt yield is down about 18bps off the peak seen earlier this month.
The 10-year gilt yield is down about 14bps off the recent peak seen earlier this month.
GBP/USD Also Off Its Recent Peak
The pound has traded considerably lower since peaking above 1.34 late last month, with GBP/USD closing below 1.3000 on Wednesday for the first time since mid-August.
Buy Price Dips in Gilts, Sell Rallies in GBP
Given the weaker data and market reaction, we see further downside for UK yields and GBP.
We think the rise in UK yields, and the GBP rally post-retail sales today, provide good opportunities to fade the up-moves.
The inflation data increases the likelihood that the BoE cuts rates twice more this year, by 25bps next month and 25bps in December. This has been our base case for some time. And the market is coming around to this notion, although the two-cut scenario is not yet fully priced.
We think there is scope for the UK 2-year yield to trade back down to ~3.75%, the low seen this time last month.
For GBP, despite the recent selloff from ~1.34 in GBP/USD, more downside also beckons. We highlight three drivers for additional GBP downside:
- Front-end rate differentials should lead to GBP weakness.
- Crowded positioning means that GBP downside will constitute a pain trade.
- Balance of payments dynamics suggest UK inflows are likely to slow, or reverse, ahead.
We think there is scope for GBP/USD to trade back to the lows seen in August, somewhere near 1.27/1.28.
.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)