Bounce-back risks on sterling

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The focus switches back to sterling today as the Bank of England presents its August Inflation Report, with labour market data preceding an hour before at 08:30 GMT. Back in June, Governor Carney initiated the sterling rally, having suggested that the market was under-estimating the risk of a rate hike this year, something which was subsequently reflected in the MPC meeting minutes. Although no member has yet to vote for a rate increase, for some the decision to keep rates on hold has become “more balanced”. Since May, we’ve seen inflation come in higher than expected, although this could be down to the timing of summer sales, so much of the increase in the headline rate may prove to be transitory. More important is the degree to which the Bank believes that the amount of slack in the economy has been absorbed more rapidly than was anticipated three months ago. This will have the bigger impact on the Bank’s view of inflation in 2 year’s time, which is what matters for the interest rate outlook. As we mentioned yesterday, sterling is clearly looking over-sold and this creates risk of short-covering rally, even on a neutral Inflation Report outcome.
To this end, sterling has already taken advantage of the softer dollar overnight to push up to 1.6825 at the start of the European session. The Aussie has led the way, aided by stronger consumer confidence data, with wage price indices falling in line with expectations. The weakness seen in Japan’s GDP data was broadly as anticipated, growth contracting 1.7% in the second quarter (QoQ measure) and leaving the economy broadly flat in the first half of the year. Of more note was the fall in new lending and aggregate financing data in China, the latter much weaker than expected at CNY 273 bln. US retail sales data the main data focus later in the day, where 0.2% gain in headline measure is anticipated.

Further reading:

EUR/USD slides on more weak inflation data

Japanese economy shrinks fast: -1.7% q/q – but it could be worse

Get the 5 most predictable currency pairs

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