On Wednesday, the British pound fell after data showed that inflation had hit its highest level in almost four decades in the previous month.
This only added more pressure on the Bank of England (BoE) to tame down the rising prices, but increased the risk of a quicker economic slowdown.
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According to official figures, consumer price inflation rose to its highest level after February 1982 at 10.1% in July.
Economists had been expecting this number to be around 9.8%, after June’s data had shown it at 9.4%.
The higher-than-expected inflation indicates that the Bank of England (BoE) will follow its last month interest rate of half a percentage point with a second similar hike in its meeting in the next month.
Money markets have now fully priced in an interest rate increase of 50 basis points in September by the British central bank and there are also outside chances of an even bigger hike of 75 basis points.
As a matter of fact, markets have priced in a total tightening of 200 basis points by May of 2023, which would put the Bank Rate at 3.75%.
Before Wednesday’s data, interest rates had been expected to reach their peak in March and a rate hike of 150 basis points had been expected.
Impact on sterling
According to analysts, even though inflation has reached its highest level seen in over four decades, the outlook for the British pound remains gloomy.
This is because the front-loading rate hikes only increase the possibility of a hard landing for the economy.
Market analysts said that sterling was strongly related to the risks of recession in the UK right now. The data released on Wednesday is expected to result in quicker rate tightening from the Bank of England (BoE).
They said that the inflation data only reinforced the risk of stagflation in the United Kingdom. No one would want to hold a currency as risky as sterling when entering a recession.
The pound had dropped by 0.24% against the US dollar at 1428 GMT at $1.2069. It had fallen 0.35% against the euro at 84.35 pence.
This was after the British currency hit its strongest level against the euro on August 4th at 83.90 pence.
After the announcement of the data, there was an increase in British government bond yields to their highest level after November 2008.
Data also showed that the gap between 10 and 2-year bond yields, which is often taken as a sign of recession, was the most negative at minus 17 basis points.
Yields on longer-dated bonds tend to be higher than short-term ones because investors want to be adequately compensated for taking on the risk of buying bonds that mature at a later date.
This month, the Bank of England (BoE) announced that it expects inflation to hit its peak in the fourth quarter of the year at 13.3%.
This is mostly because of a rise in energy prices and it also forecasted a recession that would last for five quarters.
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