Fundamental Analysis

Pound Soars to 1-Year High after Inflation Beat; Dollar also Up, Euro Under Pressure

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The British pound surged to a one-year high in European trading on Tuesday as traders bet on a more hawkish Bank of England following stronger-than-expected UK inflation data. The US dollar extended yesterday's impressive gains against the yen but the euro struggled. The New Zealand dollar was another major gainer, while gold reversed its earlier losses following fresh threats from North Korea.

The main data in today's European session was the August inflation release out of the UK. Headline inflation rose back to May's four-year high of 2.9% year-on-year in August, beating expectations of 2.8% and up from July's 2.6% rate. Core inflation was also stronger-than-expected, rising to 2.7% y/y – its highest since November 2012. Forecasts were for core CPI to rise from 2.4% to 2.5% in August.

In a further sign that the inflation upswing from the weaker pound has yet to peak, input and output prices both came in above their top estimates. The figures will likely strengthen the argument for the Bank of England hawks that interest rates need to go up. The Bank will announce its latest policy decision on Thursday and expectations have been increasing in recent days that the MPC is heading for another split vote, with more members likely to vote for a rate hike.

The pound shot to a one-year high of $1.3287 after the data, and was last trading at $1.3265, up 0.8% on the day. It was also up sharply against the euro and the yen, jumping to a more than one-month high against both currencies. The euro breached the key 0.90 level to hit a session low of 0.8981 pounds, while against the yen, the pound hit a high of 145.94.

The euro was under pressure against the resurgent dollar for a second day, sliding to as low as $1.1924 in mid-session. A converging of views by ECB policymakers that the central bank is moving towards tighter monetary policy failed to lift the single currency. Several ECB officials spoke in favour of policy normalization yesterday, though comments that the process will be gradual, as well as the potential impact of a "persistent exchange rate shock" weighed on the euro.

However, the euro later ticked higher, rising to $1.1955, as ECB Vice President Vitor Constancio started speaking. Speaking in Frankfurt, Constancio defended the ECB's unconventional policy tools and said he was confident inflation will eventually hit the target.

The greenback continued to benefit from the improving risk-on sentiment, brought on by investor relief that the impact of Hurricane Irma was less destructive than initially feared, as well as by North Korea's inaction over the weekend. The dollar briefly broke above 110 yen before dropping slightly to around 109.85 yen. The dollar index was also unable to retain a key level, slipping below 92.0 after climbing above the level for the first time this week.

The only data out of the US today was the latest JOLTS job openings. The number of job openings rose to 6.170 million in July from a downwardly revised 6.116 million in June.

The yen's and the Swiss franc's weakness were notable against all major currencies, though gold found support from ongoing unease about tensions in the Korean peninsula. North Korea issued a new threat against the United States today following the UN's decision yesterday to adopt tougher sanctions on the hermit state. The precious metal recovered from a 1½-week low of $1322.15 an ounce to rise to around $1328 an ounce in late European trading.

In other currencies, the New Zealand dollar got a boost from the latest election polls in New Zealand that put the ruling National party ahead of the Labour party. The polls lifted the kiwi to a high of $0.7320 earlier in the session before easing to around $0.7290. The kiwi has come under pressure in recent weeks from Labour's strong performance in the polls, whose campaign pledge includes scrapping the National party's planned tax cuts.

Crude oil was on track for a second day of gains as prices were boosted after OPEC raised its forecasts for demand for 2018. The group also said it had cut output in August, giving the commodity a much-needed reprieve following the dip in demand seen as a result of the refineries closures in the US due to the hurricanes.

WTI crude was last trading up 0.4% on the day at $48.26 a barrel and Brent crude was 0.8% higher at $54.29 a barrel. The API's weekly inventory report expected later today should shed more light on the impact of the hurricanes on US stock levels.

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