Comment: The UK has not stepped into deflation, sterling will continue slow rise
The unexpected 0.1% deceleration in UK consumer prices in the year to April, in the face of a 25% recovery in oil prices over the same month, has been a pure disappointment for the BoE-hawks, writes Ipek Ozkardeskaya, market analyst at London Capital Group.
Clearly, the recovery in oil markets was not expected to have a perfect linear impact on the consumer prices, simply because the buy-side has been clever enough to hedge their exposure as the entire curve was dragging lower since the beginning of the year.
Read more: UK falls into deflation in April for first time since 1960s says ONS
However, a step below the zero-line was not the consensus and has been a bit of a psychological weight around the market's neck.
Nevertheless, it is too early to say that this is the beginning of a deflationary phase in the UK because deflation-contaminated economies are generally subject to a couple of very specific risks, among which we can cite deflationary spiral and liquidity trap.
In the UK however, there are no such signs of a deflationary environment, at least not at this point. The hike in April retail sales in April supports the view that the UK consumer is not shy on spending.
Therefore, the Bank of England’s hawkish members will certainly not accept the defeat and retreat to the sidelines.
The latest BoE minutes showed that the Monetary Policy Committee expects the growth to accelerate in the second quarter and the low inflation to be only temporary.
The first hints of a pick-up in inflation should, therefore, quickly encourage at least two MPC members out of nine, to renew their call for an earlier rate increase.
This being said, the BoE is clearly not in a hurry.
With the inflation sliding to negative and the anticipation of a tighter fiscal policy, Governor Mark Carney has time before proceeding with the first rate hike.
The implied probabilities extracted from the UK’s sovereign market suggests that the expectation for a rate hike before the end of 2015 has faded from 80% to 70% since the Conservative party obtained an outright victory at the general election.
On trade-weighted basis, the pound has appreciated to seven-year highs and the eroding competitiveness of the UK companies due to expensive pound could further weigh on the trade deficit.
Especially as we are looking for more euro depreciation, the BoE would be better off with its 0.50% bank rate at least until the end of 2015.
The pound will certainly continue its advance to 65-70p range against the euro, but at slower pace.