Expectations can define reactions to news in financial markets. Forecasts for June inflation in the UK ran a little hot after May’s inflation report caught forecasters flat-footed. So when June inflation numbers came in lower than expected, financial markets experienced a sharp bout of relief. Expectations for rate hikes from the Bank of England moderated and took the British pound (GBP/USD) down with them. While the pound drifted lower after May’s inflation report, the pullback this time around was abrupt and sharp. Yet, the market may have overreacted given core CPIH (Consumer Prices Index including owner occupiers’ housing costs) continues to trend higher (core CPIH excludes energy, food, alcohol & tobacco). Core CPIH barely budged in June and left the uptrend intact even as consumer and headline inflation has clearly peaked.

The above graph shows that services inflation is the main culprit keeping core CPIH in an uptrend. Core CPIH dropped from 6.5% in May to 6.4% in June. Since May was a 30-year high, I am particularly unimpressed by the “pullback” in the core inflation rate. The Core CPI (Consumer Prices Index) dropped from 7.1% in May, a 31-year high, to 6.9% in June.

Food and energy inflation is coming off extreme levels. Food inflation is coming off a peak 19.2% in March, 2023. Fuel prices are outright plummeting, falling 13.1% in May and 22.7% in June.

The British Pound Cools with Inflation

The cooling overall inflation numbers cooled the heels of the British pound which has been on quite a streak since the bond and currency crisis 10 months ago. GBP/USD, also Invesco CurrencyShares British Pound Sterling Trust (FXB), was falling off a near 16-month high coming into the inflation print. The inflation report greased the skids on the way to an important test of the uptrending 20-day moving average (DMA). That line has held as support since the beginning of June and has been important support since early March.

The British pound (GBP/USD) maintains a strong uptrend against the U.S. dollar. The inflation report is forcing a fresh test of that uptrend. Source: TradingView.com

For now, I am trading for a bounce from the 20DMA and prepared to to accumulate a larger position for a test of 50DMA support. The overall drivers of sterling strength seem intact as long as core inflation is uptrending or even just sticky. The Bank of England will have to remain as hawkish as ever.

Of course, the upcoming meeting of the U.S. Federal Reserve is a major wildcard. If the Fed manages to get hawkish enough to scare some fresh strength into the U.S. dollar, then I will have to drop my current trading strategy.

Regardless, the uptrend in the pound should at some point end in the coming months. This recent weakness in the currency could be the beginning of the end.

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