UK Services Inflation Still Too High For BoE's Comfort

UK’s CPI growth stands right on the Bank of England’s (BoE) 2% target. However, services inflation remains sticky, growing at a constant 5.7% y/y in June. Moreover, the deceleration in wage growth remains insufficient to temper inflationary pressures in the services sector.

Our European Investment strategists had previously highlighted that a post-Brexit UK is subject to relatively stronger supply constraints than the rest of the world, while the fiscal response to the pandemic continues to foster an environment of excess demand. Both factors are contributing to sticky wage growth.

Both services inflation and wage growth need to decelerate in order to declare a sustainable return to target inflation. Despite striking a dovish tone at its June policy meeting, the BoE is therefore unlikely to cut rates in August, and likely to lag its G10 peers in easing monetary policy. Interest rate differentials are thus supportive of the pound in the short term.

However, GBP/USD hit a one-year high against the greenback and this cross broke above its key moving averages. Our FX strategists highlighted that net speculative positions are very long the pound relative to the dollar. They would fade any further strength in GBP/USD and recommend selling this cross if the 1.32 threshold is reached.