Key data releases out of the UK are likely to once again find themselves fighting for attention amid a deepening Brexit turmoil. But although there will be bigger stories than economic indicators dominating the headlines for sterling traders over the next few days, the data could nevertheless provide some clues as to the likelihood of a Bank of England rate hike should the Brexit storm clear up. The CPI report is due on Wednesday at 09:30 GMT, while the retail sales numbers are out on Friday at the same time.
UK inflation is expected to have moderated slightly from 2.3% to 2.1% year-on-year in December, probably on the back of falling fuel prices. This would take the headline rate of CPI to just above the Bank of England’s 2% target, suggesting little need for monetary tightening. The core rate of CPI is forecast to hold steady at 1.8% y/y in December.
Inflationary pressures are likely to subside further over the coming months following the steep sell-off in oil prices in the final three months of 2018. However, with wage growth picking up in recent months and the UK economy operating close to full capacity, the BoE would probably see through the temporary drop in fuel and energy prices in its inflation projections.
There are significant downside risks though, namely, the ongoing Brexit uncertainty and a slowing global economy. UK growth was lifted in the third quarter from strong consumer spending but there are signs households reined in their expenditure in the fourth quarter. Retail sales are forecast to have fallen by 0.8% month-on-month in December, after jumping by 1.4% in November following the boost from Black Friday deals. The annual rate is expected to stay unchanged at 3.6%.
A bigger-than-anticipated drop in retail sales in December would point to a sharper slowdown in the fourth quarter, as well as raise doubts about the outlook for 2019. The Bank of England is unlikely to raise interest rates if growth slows down more than expected and there is still no agreement on Brexit. On the other hand, any deal on Brexit would dramatically increase the odds of a BoE rate hike, lifting sterling.
However, until there’s more clarity on the Brexit front, pound/dollar could be stuck in a wide choppy range. Cable could retest the 1.29 level if Tuesday’s expected rejection of the Brexit deal in Parliament doesn’t lead to a market panic and the data is mostly positive. A break above the 1.29 handle would open the way for the 161.8% Fibonacci extension of the downleg from 1.2814 to 1.2436, at 1.3048.
But should Parliament descend further into chaos after the vote and this week’s releases disappoint, pound/dollar could slip back below the $1.28 level and head for the 1.2733 support, which is the 78.6% Fibonacci retracement. A sharper drop could see the pair breaching the 50% Fibonacci at 1.2625 before diving towards the 21-month low of 1.2436 touched earlier this month.
