UK CPI set to cool down further in May, reaching BoE’s 2% target

• The UK Office for National Statistics will publish the May CPI report on Wednesday.
• UK inflation is expected to cool down, falling back to the BoE´s target.
• The Bank of England will announce its decision on monetary policy on Thursday.
• The Pound Sterling is expected to post a wild reaction to inflation data.

The United Kingdom’s (UK) Office for National Statistics (ONS) will release the May Consumer Price Index (CPI) report on Wednesday at 06:00 GMT. At the same time, the ONS will publish the Producer Price Index (PPI) figures for the same period. 

Inflation in the United Kingdom remains above the Bank of England’s (BoE) 2% target. According to the latest data, the UK CPI grew by 2.3% year-over-year (YoY), while core annual inflation posted 3.9% in April. Market participants expect the CPI to have risen 2% YoY in May, matching the BoE’s goal for the first time in roughly three years.

What to expect from the May UK inflation report?

Financial markets anticipate the UK headline CPI rose 2% YoY, while the core annual reading is foreseen at 3.5%. Those figures would be an improvement from April readings, when the CPI rose 2.3%, while the core reading, excluding volatile food and energy prices, hit 3.9%. 

However, May monthly inflation is seen up 0.4%, following the 0.3% posted in the previous month. It may not be a really worrisome outcome, yet markets may be discouraged by an uptick in price pressures, even if it’s this low. 

The BoE´s Monetary Policy Committee (MPC) left interest rates unchanged at a multi-year high of 5.25% when it met in May, although two out of the nine voting members preferred to trim rates by 25 basis points (bps).

"We are not yet at a point where we can cut the base rate," BoE Governor Andrew Bailed said, although policymakers acknowledged the steady decline in inflation. The central bank economic projections released alongside the May meeting showed consumer inflation is projected to approach the 2% target in the near term but could edge up later in the year due to the unwinding of energy-related base effects. Policymakers also remarked that service sector inflation remained at 6.0% as of March, more than doubling the BoE’s goal. 

Would a 2% print be enough to trigger a rate cut as soon as this week? That seems tough but not impossible. Market players may pay attention to headline figures, but policymakers will rather focus on service inflation. A sharp drop in the latest, alongside headline readings in line with expectations, will definitely lift the odds of an interest rate cut in June. Before the inflation-data release, however, market participants believe the BoE will keep rates on hold for one more time.  

When will the UK Consumer Price Index report be released and how could it affect GBP/USD?

The UK will publish CPI and PPI data on Wednesday at 06:00 GMT. The Pound Sterling (GBP) is trading below the 1.2700 mark against the US Dollar (USD), with the latter maintaining a firmer tone ever since the United States (US) reported price pressures kept easing in May. The US Federal Reserve (Fed) kept rates unchanged regardless and announced it may deliver one or two rate cuts before year-end. 

For a change, the Fed did not deliver ahead of its major counterparts, as the Bank of Canada (BoC) and the European Central Bank (ECB) have already trimmed rates. That means the BoE may proceed with more confidence once inflation falls into policymakers’ comfort zone. 

With that in mind, the figures released on Wednesday could trigger some wild price action around GBP crosses. Generally speaking, higher-than-anticipated readings should signal a steady BoE and, hence, underpin the Pound. 

Should inflation-related figures come in below the market expectations, speculative interest will rush to price in a rate cut as soon as this week and put pressure on GBP. Bear in mind market players may opt to remain pat ahead of the BoE’s announcement 24 hours later. 

Valeria Bednarik, Chief Analyst at FXStreet, says: “The GBP/USD pair has held around the 1.2700 mark for five consecutive weeks, showing little sign of directional progress. It reached a peak at 1.2859 on June 12, while the bottom has been set in the 1.2660 price zone. Ahead of the announcement, GBP/USD loses strength and nears the lower end of the aforementioned range. Technically speaking, the case for a bearish extension has become firmer in the daily chart as the pair develops below a now flat 20 Simple Moving Average (SMA) while approaching a directionless 100 SMA, providing dynamic support at around 1.2640. Technical indicators, in the meantime, hold within negative levels, although with uneven strength, not enough to anticipate a directional movement.”

Bednarik adds: “If GBP/USD breaks below the 1.2640/50 area, the pair can quickly reach the 1.2600 mark en route to 1.2520. The upside seems more messy. Sellers have rejected advances around 1.2800, while the peak at 1.2859 is also relevant. A sharp rally could be expected on a breakout beyond the latter, but this is not likely until after the BoE’s announcement on monetary policy.