FTSE boosted as weaker UK inflation hits pound again

After the sluggish wages data yesterday, the pound was hit again this morning on news UK inflation remained flat in June, raising further doubts over an August rate hike from the Bank of England. But this was good news for the stock markets, with the commodity-heavy FTSE 100 extending its gains after a sizeable rally the day before and despite ongoing weakness in prices of crude oil and metals.

CPI unchanged in June

The Office for National Statistics reported that the headline consumer price index (CPI) measure of inflation remained unchanged at 2.4% year-over-year in June. This was below expectations for a rise to 2.6%. Meanwhile core CPI eased to 1.9% from 2.1% previously, while other key measures of inflation, including the Retail Price Index, House Price Index and Producer Price Index (both input and output prices) all disappointed expectations, too. The ONS said the increase in transport costs were offset by falling prices of food, clothes and recreation and culture.

Could the pound rebound anyway?

While everything – from soft UK data to ongoing Brexit-related political uncertainty – points to weakness for the pound, it is worth remembering that sterling had been falling sharply of late as some astute investors had already anticipated this outcome. Therefore, profit-taking from this group of market participants could help fuel an unexpected short-squeeze rally in the pound, particularly given how negative sentiment is at the moment. But for the pound’s longer term outlook to turn bullish we will need to see a positive change in fundamental data or political outlook, and ideally backed by evidence of a technical turnaround. Until these conditions are met, any short term bounces in sterling should be taken with a pinch of salt. That said, we expect UK inflation to push higher thanks to the hot weather over the past month and a half, with England’s unexpected ‘success’ at the FIFA Wold Cup also likely to have caused inflationary pressures in some sectors of the economy.

Poor data is good news for UK stocks

While the pound extended its declines further today, this was good news for UK stocks. A weaker pound helps to boost exports and overseas earnings when converted back to sterling. What’s more, the fact that there will now be slightly less urgency for the BoE to hike interest rates, this will help keep borrowing costs – or expectations thereof – low for a little longer for both consumers and businesses,. This should boost spending and therefore company profits, or so the theory goes. And finally, the resulting lower bond yields is likely to boost the appeal of the higher-yielding stock markets for investors seeking yield.

FTSE in good technical shape

The FTSE was hitting new highs on the week at the time of this writing, making good its losses suffered on Monday. The resulting candlestick pattern on the weekly chart of the FTSE is a hammer. Assuming the index does not fall back sharply in the second half of the week, this is a bullish formation for it shows the buyers have overtaken from the sellers who were in control earlier in the week. What’s more, the 21-week exponential moving average has again provided support, keeping the FTSE in the sweet spot and the bias firmly in the bullish territory. And let’s not forget the index’s v-shaped recovery that was formed following the sell-off in Q1. Usually, v-shaped recoveries are very bullish, for they highlight the sheer resilience of the bullish participants. If resistance at 7700 breaks now then a subsequent really to a new all-time high could not be ruled out. The FTSE’s previous high of 7903.50 was hit in May before the index drifted lower, possibly because of profit taking from the “Sell-in-May-and-go-away” participants (hence, the pullback has been relatively shallow, suggesting the long-term trend is still bullish).

While we clearly expect to see higher index levels for the FTSE, we are obviously aware of the risks posing the UK benchmark index, not least the ongoing weakness in commodity prices and upcoming earnings. Technically, though, we would only turn bearish in the event the FTSE breaks below support and the 21-week EMA at 7550/60 area, or forms a distinct reversal pattern at higher levels first.