British Pound strengthens after US CPI surprises to the downside

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GBP/USD rises following softer-than-expected US inflation data.
Traders scale back near-term Fed rate-hike bets, weighing on the US Dollar and Treasury yields.
Renewed US-Iran tensions and rising Oil prices keep inflation risks alive.

The British Pound (GBP) strengthens against the US Dollar (USD) on Tuesday after US inflation data surprised to the downside, reducing expectations of a near-term Federal Reserve (Fed) interest rate hike. At the time of writing, GBP/USD trades around 1.3415, up nearly 0.50% on the day and hovering near a one-month high.

The US Consumer Price Index (CPI) fell 0.4% MoM in June, following a 0.5% rise in May. The reading came in below the forecast of a 0.1% decline. Annual inflation eased sharply to 3.5% from 4.2%, below the 3.8% forecast.

Core CPI, which excludes volatile food and energy prices, was flat on a monthly basis, missing expectations for a 0.2% increase. The annual core rate slowed to 2.6% from 2.9%, below the 2.8% forecast.

In reaction to the data, traders quickly scaled back Fed rate-hike bets, pushing the US Dollar and US Treasury yields lower. The US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, trades around 100.70, retreating from an intraday high of 101.32.

According to the CME FedWatch Tool, the probability of a July hike fell to 16% from 40% before the CPI release, while the odds of a September increase eased to 60% from 74%.

However, the softer inflation figures could prove temporary, as the decline was largely driven by lower energy prices following last month’s interim peace deal between the US and Iran.

With tensions rising again and Oil prices moving higher, inflation risks remain alive, keeping the possibility of a Fed rate hike later this year on the table.

Traders now await Fed Chair Kevin Warsh’s congressional testimony, along with speeches from Fed officials Michael Barr, Austan Goolsbee and Lisa Cook.

Fed FAQs

What does the Federal Reserve do, how does it impact the US Dollar?

Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.

How often does the Fed hold monetary policy meetings?

The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.

What is Quantitative Easing (QE) and how does it impact USD?

In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.

What is Quantitative Tightening (QT) and how does it impact the US Dollar?

Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.