This post is taken from our April 24th weekly report.
Much like the Federal Reserve, the Bank of England has been itching to normalise monetary policy following nearly a decade of providing emergency assistance to the economy. Buoyed by the run up in prices over the past 18 months, the BoE delivered its first cyclical hike in November. However, as we have warned in our March 2018 Monthly report and in recent weekly reports, we like fading BoE hikes and continue recommending selling rallies in GBPUSD and positioning for front-end curve flattening. The previous inflation surge was driven by supply-side factors (sterling depreciation, higher energy prices) which are now decaying.
Our UK core inflation model (top left) suggests that a disinflationary trend is emerging. While the BoE has downplayed recent weaker CPI prints by highlighting the relative strength of wages (top right chart), the actual correlation between wages and 1y lagged CPI is quite low historically. Inflation expectations remain capped (bottom left chart), while the slowing pace of crude oil gains will reduce some of the upward pressure on UK CPI (bottom right chart). As inflation rolls over, it will undermine the cable rally and further support our Short-Sterling curve flattener view.
(Click on image to enlarge.)
Source: Bloomberg, Macrobond and Variant Perception