Pound Buoyed as Data Spur Wagers U.K. Inflation Is Bottoming Out

  • U.K. annual core inflation quickens to 1.1% in October
  • BOE's Carney has highlighted core rate as measure to watch

The pound rallied from its lowest level in almost a week versus the dollar as faster-than-predicted core inflation encouraged investors expecting an interest-rate increase next year.

Sterling also climbed to the strongest level against the euro since August after the Office for National Statistics said core inflation, which excludes volatile food and energy prices, rose to 1.1 percent in October from 1 percent the previous month. Analysts surveyed by Bloomberg forecast no change. Bank of England Governor Mark Carney has highlighted the measure as an important gauge for policy makers as they consider when to start raising rates.

The data support “Bank of England hawks,” said Jane Foley, senior currency strategist at Rabobank International in London.

“Core inflation has picked up a bit, and that’s an important measure to watch as it looks through volatile items and focuses on domestically generated price pressure,” she said. “Price pressure overall is still moderate, but this could be the trough of the cycle. This should limit the selloff in sterling.”

The pound rose 0.1 percent to $1.5216 as of 5:15 p.m. London time, after falling 0.3 percent before the data were published to the lowest since Nov. 11. Sterling advanced for a third day against Europe’s shared currency, gaining 0.6 percent to 69.85 pence per euro, its strongest level since Aug. 6.

Yields Jump

U.K. government bonds fell, with the 10-year gilt yield climbing four basis points, or 0.04 percentage point, to 1.98 percent. That’s the first yield increase in four days and the biggest since Nov. 6. The 2 percent security due September 2025 dropped 0.33, or 3.30 pounds per 1,000-pound face amount, to 100.21.

The yield will rise to 2.18 percent by the end of March and 2.25 percent by mid-year, according to median forecasts of strategists surveyed by Bloomberg.

Sterling was supported even as headline consumer prices fell for a second month, extending the weakest bout of inflation in more than half a century. Prices declined 0.1 percent from a year earlier, making it almost two years since inflation has achieved the BOE’s 2 percent target.

Optimism, Pessimism

In the central bank’s Inflation Report of Nov. 5, officials nevertheless said they expected temporary factors such as oil-price declines to wash out next year, helping them achieve their price goals. Officials want to see an improving economy before they start to raise the main rate from the record-low 0.5 percent it’s been at since 2009.

Investors have pared back the probability of a boost to U.K. borrowing costs next year. Less than a week ago, markets were signaling a possible rate increase in November 2016, but forward contracts based on the sterling overnight index average, or Sonia, now don’t price it in until after January 2017.

That’s way too pessimistic, according to Alan Clarke of Scotiabank Europe Plc, one of 20 gilt primary dealers that deal directly with the U.K.’s debt agency.

“I certainly think we’re bottoming out” on inflation, “but that’s due to the petrol base effects,” said Clarke, a London-based economist at the bank. “It’s more likely that the Bank of England will raise interest rates in the first half of next year than in the second.”

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