US Inflation Matches Forecasts

US inflation landed in line with consensus this afternoon, and that is arguably the main story.

Headline CPI rose 0.1% in July, with annual inflation easing from 3.5% to 3.4%. Core CPI, which excludes food and energy, increased 0.2% on the month, while the annual rate fell from 2.6% to 2.5%.

The major figures were therefore in line with expectations.

The direction remains encouraging for the Fed.
 
If the recent pace of disinflation continues, inflation should gradually move closer to the Federal Reserve's objective. However, the Fed targets 2% inflation as measured by the PCE price index, rather than CPI, and underlying inflation remains high enough to keep the debate over further tightening alive.

GBP/USD entered today's release close to a one-month high following the Dollar weakness triggered by last week's disappointing US employment report.

That jobs report materially changed expectations for the Federal Reserve. Immediately before the employment figures, markets were pricing around a 57% probability of a September rate hike. Following today's CPI release, that probability stands at approximately 42%.

Today's inflation numbers were effectively the middle-ground outcome. A materially softer core reading would have made another hike increasingly difficult to justify, while a hotter reading could have quickly revived the hawkish argument. Instead, the Fed is left balancing inflation that remains above target against a labour market that has begun to show signs of weakening. 

GBP/USD has therefore remained firm, with the Pound holding its recent gains. EUR/USD has found support at broadly similar levels to a year ago and the relatively muted reaction across markets reflects how closely today's numbers matched expectations. 

Falling energy prices helped considerably in July. Energy prices declined 1.5% on the month, with gasoline falling 2.9%, following an even larger decline in June.

However, today's CPI report is backward-looking. It does not capture the latest rise in oil prices during August, with Brent crude trading close to $90 per barrel amid continued geopolitical tensions.

That matters because some of the energy-driven improvement seen in July could reverse if oil prices remain elevated. The length of the current energy shock may therefore become increasingly important when the Fed meets in September.

US Producer Price Index data is also released tomorrow and will provide another piece of the inflation picture before markets can form a clearer view of the Fed's preferred PCE measure.

USD/CAD
The Canadian Dollar has seen a more notable move. USD/CAD has fallen with CAD reaching its strongest level in two months this week. Higher oil prices have provided additional support to the Canadian currency, while expectations of further Federal Reserve tightening have softened.

For GBP, the focus now shifts quickly back to domestic data.

UK Q2 GDP is released tomorrow, Thursday 13th August, with markets expecting growth of around 0.4% quarter-on-quarter, following 0.6% in Q1.

A stronger reading would reinforce the view that the UK economy remains resilient and could keep expectations of further Bank of England tightening alive.

Both releases will help determine whether resilient growth, persistent inflation and continued consumer spending can provide further support for Sterling.

What this means for businesses

With UK GDP tomorrow, followed by inflation and retail sales next week, several important events remain capable of moving exchange rates quickly. Businesses with known upcoming payments may therefore want to keep their currency exposure under review.