Noflation or Deflation

19 May, 2015

Tom Arnold

Today the markets focus is almost completely taken by the 9.30am release of UK CPI Inflation. Last week Bank of England Governor Mark Carney discussed the probability of the UK heading down below the current 0% inflation figure (Noflation) into a negative figure (Deflation). The Bank has a 2% inflation target, so is “failing” to achieve this, but the Governor is quite content that things are as expected and that once various economic factors have played out that this will be back on track.

In the mean time this is good news for those of us with purchases to make and politically importantly for the “cost of living crisis” debate, but most importantly from a Pound perspective; this is important because it affects the Bank of England’s policy on interest rate changes. Higher inflation provides room for interest rate hikes, whereas lower inflation normally encourages interest rate cuts. With interest rates at historic lows already, further cuts are seen as very unlikely, but the low inflation rate does mean that the chances of any hikes are non-existent in the short term and likely not to come into play until well into 2016.

The reason this matters so much for the Pound is if interest rates go up, then investors will come calling for the higher yield and investment in a currency provides strength to that currency. So speculation on interest rate changes can cause big moves on the market as those big investors move their funds around searching for this highest yield. At the moment there is a race occurring between the UK and the US as to who is going to raise rates first. The US had been winning easily until a recent slowdown in almost all economic data caused analysts to put back the chances of a rate hike in the short term. Will the UK inflation figure today stick at 0%, or drop below as Mark Carney suggested? The answer could well see the UK drop back further in this race or make up some lost ground.

Yesterday’s market movement suggested investors thought the figure might be lower with the Pound losing out throughout most of the day, but then late afternoon and this morning already, the Greek situation took hold. German bond yields failed to impress in comparison to their US counterparts and as a result the Euro has lost significant ground and the Dollar has pulled back strongly.

What this means for those with a Euro requirement is a possible short term window of opportunity – at 9.30 if inflation is low the Pound will almost certainly drop, but in the mean time we are only 2-3 cents off the recent 8 year high for buying Euros.

Your CI broker is ready and waiting to help you secure your currency if you want to take advantage of this situation before things possibly drop away.