UK CPI to Drop Dramatically

UK inflation is expected to come down substantially, but stickiness in the components will likely keep the BOE on a hiking path.

Highly Unlikely to Stay in Double Digits

Yearly UK inflation is expected to finally drop below double digits unless there is a significant change in the situation. April 2022 saw an extraordinary monthly increase in CPI of 2.5%, driven primarily by a hike in energy costs authorised by Ofgem. Since then, the median monthly inflation rate has been in the order of 0.5%, and March saw a 0.8% increase.

For inflation to stay in double digits, it would necessitate a monthly rate of 2.5%, or 2.0% above the average of the last few months, or a whopping 1.7% increase above March, which is highly unlikely. Monthly inflation is expected to remain at 0.8%, which is still way beyond the comfort level of the BOE. Consequently, even though policymakers might celebrate a sudden drop in the headline cost of living increase rate, it likely won't move the BOE's outlook.

BOE Unlikely to Change Course

The BOE that inflation will come down sharply thanks to more volatile components, such as the cost of imported goods and energy coming down. But, concerning policy, the BOE cares more about the core rate, excluding volatile components. The annual core rate is expected to budge barely, ticking down to 6.1% compared to 6.2% prior.

Where markets could find some cheer is with the PPI, with annual output and input rates expected to fall over 200bps, suggesting that inflation pressures might indeed be abating. But it would likely take a substantial miss on expectations in the core monthly rate to change the narrative on what the BOE will do at the next meeting.

Pound in H&S Pattern?

Cable has fallen substantially since the peak of $1.2690, but the downward leg might end up bouncing near $1.2336, resembling a head-and-shoulders. If the right shoulder has not been completed yet at $1.2555, a support rejection might send the pair near $1.2563, where it would be expected to terminate. This would be followed by a drop to the golden pocket of $1.2159, the typical depth of an H&S, before a continuation to the predominant trend: up.

The short-term pattern shows a wedge that might have completed at $1.2398 unless bears go for a double bottom by the 38.2% Fibonacci of the $1.1832-$$1.2690 leg. In that vein, any upside is expected to be restricted to a correction only. Otherwise, the H&S might have been completed already.

Key Takeaways

UK inflation is expected to drop below double digits, but components of the rate may remain sticky. Regardless, the BOE is unlikely to alter its rating path, as it is more concerned with the core rate, which is predicted to change slightly.