Will the stronger pound lead to larger interest rate cuts by the Bank of England (BoE)? Does the recent strength of the Pound Sterling (GBP) mean that imported inflation will be lower and, conversely, that the Bank of England (BoE) will be able to cut interest rates more quickly? In principle, this is a very fascinating idea, and not just for the BoE, Commerzbank’s FX analyst Michael Pfister notes.

UK inflationary pressure now comes from services

“If central banks that are currently struggling with more stubborn inflationary pressures become relatively more hawkish, will the associated currency appreciation cause these inflationary pressures to subside? This in turn would lead to faster rate cuts. The best examples would be the Norges Bank and the Reserve Bank of Australia, next to the BoE.”

“In the UK, almost all inflationary pressure now comes from services. The role of goods is less important. In fact, in recent months we have even seen outright goods deflation in some areas, which has helped to push down the core rate. The slight turnaround that has since taken place confirms our view.”

“Since the beginning of the year, the GBP has gained almost 5% against the USD. That makes it by far the best performing G10 currency, but it probably won't be enough. GBP would probably need to appreciate much more for the persistently high services inflation to narrow the gap between the core rate and the target.”