Sterling approached its weakest level against the euro in 10 months on Tuesday and fell against the dollar, as the latest snapshot of UK inflation underlined the squeeze on consumers but failed to fan expectations the Bank of England would raise interest rates.
The UK currency added to its more than 6 per cent drop against the euro this year, sliding as much as 0.5 per cent to fetch £0.9134 against the single currency. It dropped 0.8 per cent to $1.2865 to levels last seen in early July.
The weakness in sterling came despite the UK government declaring its ambition to stay in a customs union with the EU for several years after its 2019 exit from the trading bloc. While sterling has proved particularly sensitive to developments in negotiations with the EU since the 2016 Brexit vote, traders and investors have recently given more focus to signs of deterioration in the economy.
The collapse in sterling that came immediately after the Brexit vote has contributed to higher inflation by raising the cost of imports. July’s data from the Office for National Statistics showed annual inflation remained at 2.6 per cent, but fell just short of economists’ expectations of a 2.7 per cent rate.
The figures, in which falling fuel prices were offset by more expensive food, clothing and household goods, raised questions over the Bank of England’s projection this month that inflation will peak at 3 per cent in October.
“We’re in trade-off territory,” said Sam Hill, an economist at RBC Capital Markets. “It’s ambiguous, because at the moment counter to what will often be the case, when you’ve got higher inflation it just probably implies the economy will be performing more poorly, because it’s going to constrain consumers’ real income.”
“It’s far from clear it will lead to higher interest rates,” he added, and does not expect the BoE’s policymakers to raise rates for “the foreseeable future”.
UK monetary policy has already been complicated by the uncertainty around Brexit negotiations, even as other central banks are seen to be edging towards tighter policy. Mark Carney, the bank’s governor, this month pointed to the “extraordinary nature of the Brexit process”.
Before this month’s meeting of rate setters, markets were pricing in expectations of an interest rate rise later this year. Afterwards, expectations for the first full 25 basis point rise were pushed back to the end of 2018.
News that the UK will seek to maintain its current customs arrangements — a victory for supporters of a smooth exit — failed to stem the pound’s weakness. “In reality, even hardline Brexiteers were calling for this,” analysts at Citi noted, though added it was “no doubt a positive step”.
Recent market discussion of sterling has also pointed to the consequences of Labour’s strong showing at the June general election.
“Given the Labour party’s recent strong election showing, any prospect of an early election would put GBP under immediate selling pressure,” analysts at Morgan Stanley argued last week. “The Labour party’s agenda suggesting higher taxes on corporates and high income earners may weaken investment further, and may even lead to substantial capital outflows,” they added. “GBP-denominated assets including housing may find it difficult to rally.”
In gilt markets, yields on two-year UK government debt edged up 2 basis points to 0.24 per cent.