GBP/USD trades modestly higher on Wednesday as the US Dollar comes under mild pressure following the release of the latest US inflation figures. However, the market reaction remains limited as the data broadly matched expectations. At the time of writing, GBP/USD trades around 1.3523, near its highest level since July 16.
The headline Consumer Price Index (CPI) rose 0.1% in July after falling 0.4% in June, with the annual rate easing to 3.4% from 3.5%. Core CPI increased 0.2% MoM following a flat reading in June, while the yearly rate slowed to 2.5% from 2.6%.
The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, trades around 99.67, down 0.15% on the day. US Treasury yields also edge lower across the curve, with the two-year yield down 4.6 basis points from the daily open of 4.220%
The in-line data offered traders little relief as inflation risks remain tilted to the upside due to elevated energy prices. Hopes for an immediate reopening of the Strait of Hormuz remain low, keeping a geopolitical risk premium embedded in Oil prices. West Texas Intermediate (WTI) trades around $81.60 per barrel, up more than 6% so far this week.
Against this backdrop, traders expect the Federal Reserve (Fed) to maintain a restrictive policy stance until inflation shows clearer signs of moving toward its 2% target. However, the probability of a rate hike at the September meeting has fallen to 38% from 44% before the data, according to the CME FedWatch Tool.
Attention now turns to preliminary UK second-quarter Gross Domestic Product (GDP) data and the US Producer Price Index (PPI), due on Thursday. The releases could provide fresh direction for the pair.
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it.
Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.