Inflation trumps retail sales for sterling speculators

By Alun John

LONDON (Reuters) – Sterling traders are betting that sticky inflation will outweigh slowing retail sales when the Bank of England puts economic data on the scales and makes its next interest rate decisions.

The pound finished the last, data-packed, week slightly stronger against the euro for a fourth successive time, and is up year-to-date on all G10 currencies barring the resurgent U.S. dollar.

The latest data from the U.S. markets regulator meanwhile showed speculators adding to their bullish bets on sterling for a third week in a row.

The takeaway from data showing slowing wage growth, an unexpected uptick in inflation and a sharp plunge in retail sales is that the Bank of England is still likely to lag the Federal Reserve and the European Central Bank when it comes to rate cuts, for now the main question for the British currency.

Market pricing currently reflects roughly a 50% chance the Bank of England will cut rates by 25 basis points in May, with a reduction fully priced for August.

Traders think the ECB will most likely begin rate cuts in April, and are pricing a near 50% chance of a U.S. rate reduction as soon as March.

Prioritising lower inflation would typically cause central bankers to keep rates higher, while a focus on boosting a slowing economy could lead to rate cuts sooner.

“For the BoE to become more confident that they can begin to lower rates to provide more support for growth in the UK, they will need to see further evidence that persistent inflation risks are diminishing,” said Lee Hardman, senior currency analyst at MUFG.

“While the weak retail sales report from the UK (on Friday) has taken some of the shine off the pound, it is still the second best-performing G10 currency at the start of this year.”

The most recent weekly figures on investor holdings of currency futures show the net long sterling position – based on the assumption that the pound will increase in value against the dollar – grew for a third week by nearly $800 million, or 48%, to $2.24 billion, its biggest in four months.

Just two months ago, speculators held a short sterling position worth around $2.166 billion.

The positioning data spans the trading days from Jan. 10 to Jan. 16 and doesn’t capture the reaction among the investment community to last week’s inflation numbers. A surprise uptick in December to 4.0% from 3.9% a month earlier would seem to argue for speculators to add to this growing bullish position.

The pound has performed particularly strongly versus the Japanese yen, up 4.7% year to date, and the Australian dollar, up 3%. Against the Swiss franc, it has gained 2.8%, with analysts at Nomura forecasting a further rise of nearly 3%.

Flash PMI activity data on Wednesday will give a further sense of the state of the British economy.

The impact on British stocks of last week’s data – both slowing growth and inflation that could keep borrowing costs higher for longer – is clearer-cut.

The blue-chip FTSE 100 index shed over 2% last week with the mid-cap FTSE 250 down 1.7%, both underperforming the European benchmark STOXX 600..

(Editing by Amanda Cooper and Catherine Evans)