Inflation warning! CPI may explode, the Bank of England interest rate cut dream?

The UK Office for National Statistics (ONS) will release August consumer price index (CPI) data at 14:00 Beijing time on Wednesday (September 17), which has high market influence. On the eve of the Bank of England's interest rate decision on Thursday, this inflation report may significantly affect the direction of the central bank's monetary policy and the performance of the pound exchange rate.

What are the market expectations for the UK inflation report?

The UK CPI is expected to rise to 3.9% year-on-year in August from 3.8% in July, although the reading is in line with the Bank of England's forecast but still nearly double its 2.0% target.

Core CPI inflation, which excludes energy, food, alcohol, and tobacco prices, is expected to decline from 3.8% in July to 3.6% in August.

According to a survey of economists by Bloomberg, official data are expected to show that services inflation remains well above the Bank of England's 2 per cent target - up 4.8 per cent year-on-year in August from 5.0 per cent previously.

In addition, the monthly rate of CPI in the UK is expected to rise by 0.3% in August, an acceleration from the 0.1% increase in July.

"We expect the CPI data to be divergent - core inflation is below market consensus but in line with MPR forecasts; headline inflation is forecast at an annualised rate of 3.9 per cent, slightly above market and BoE expectations," TD Securities analysts said in a pre-release note.

How will the UK CPI report affect the pound against the dollar?

A slight rise in UK inflation expectations and a cooling labour market are likely to jointly determine the path of interest rates after September's expected hold-up by the Bank of England. Annual growth in regular pay excluding bonuses slowed from 5 per cent to 4.8 per cent in the three months to July, and the unemployment rate remained unchanged at 4.7 per cent, both in line with market expectations, according to the latest labour data from the Office for National Statistics.

At the same time, most economists expect a 25 basis point rate cut in the first quarter of next year, and market bets on a rate cut in November have increased. At its August monetary policy meeting, the Bank of England cut the base rate to 4%, but after an unprecedented second round of voting, the decision was finally passed by a narrow 5-4 margin.

The Bank of England reiterated its "gradual caution" guidance on further reductions in borrowing costs, but added that "monetary policy constraints have weakened as policy rates have fallen".

Therefore, if the headline inflation data is higher than expected, it will "pour cold water" on the expectation of interest rate cuts this year, in which case the pound is expected to receive a much-needed boost, pushing the pound to the 1.3700 mark against the dollar. Conversely, an unexpected slowdown in the annual CPI could increase the probability of a rate cut in November, which could seriously weigh on the pair.

FXStreet Chief Analyst Dhwani Mehta gave a brief technical outlook for the pair:dooprime"GBP/USD is currently trading at a two-month high above 1.3600, with the 14th Relative Strength Index (RSI) momentum indicator pointing upwards above the 50 level."

"The pair needs to effectively break through the psychological level of 1.3650 in order to extend the rally to the 1.3700 threshold. The next upside target points to the July high of 1.3789. On the contrary, the initial support is around 1.3550, and if it misses the rule, it may lower the 21-day simple moving average (SMA) at 1.3512. The deeper support is found in the area where the 50-day (1.3464) and 100-day moving averages (1.3474) converge (near 1.3470), which will be the last line of defense for the buyer."

(Daily chart of the pound against the dollar, source: Internet)

At 13:47 Beijing time, the pound was trading at 1.3644/45 against the dollar.