The euro (EUR) remains vulnerable against the British pound (GBP) on Tuesday, circumscribed below 0.8650, consolidating losses from the previous two trading days. Higher euro zone inflation data did not provide significant support for the euro as it does not change the view that the European Central Bank (ECB) will raise interest rates next week.
Preliminary data published by Eurostat on Tuesday showed that the harmonized index of consumer prices (HICP) for the euro area accelerated to an enhance of 3.2% year-on-year (y/y) in May, in line with market expectations, from 3.0% (y/y) in April. Similarly, the core HICP rose to a one-year high of 2.5% in the 12 months to May, up from 2.2% in April, above market expectations of a 2.4% enhance.
The data confirms the inflationary impact of the energy shock from the Iran war, while the rise in core inflation suggests that price pressures are spilling over into the broader economy, increasing pressure on households and businesses. This virtually confirms a 25 basis point enhance in interest rates at next week’s monetary policy meeting.
On the other hand, sterling is showing some strength as Prime Minister Keir Starmer appears to have resisted calls to resign following May’s disastrous local election result, easing concerns about losing power, at least for now.
On Tuesday, consumer lending fell to £1.86 billion in April from an upwardly revised £1.90 billion in March, while the number of mortgage loans approved rose to 65.94,000. from 63.97 thousand in March, given market expectations for a moderate decline. Net lending to individuals fell to £6.2 billion in April from £8.7 billion in March. However, the pound was not moved by these data.
Frequently asked questions about inflation
Inflation measures the enhance in prices of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a monthly (m/m) and annual (y/y) basis. Core inflation excludes more volatile items such as food and fuel, which can fluctuate due to geopolitical and seasonal factors. Core inflation is the figure economists focus on, and it is the level aimed at by central banks, which are required to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (m/m) and year-on-year (y/y) basis. Core CPI is the figure that central banks target because it does not include variable spending on food and fuel. When core CPI rises above 2%, it typically results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
While it may seem counterintuitive, high inflation in a country causes the value of its currency to enhance, and vice versa for lower inflation. This is because the central bank usually raises interest rates to combat higher inflation, which attracts more capital inflows from around the world from investors looking for a lucrative place to put their money.
Historically, gold was the asset that investors turned to in times of high inflation because it held its value, and while investors will often continue to buy gold for its safe and sound haven property in times of extreme market turmoil, in most cases this is not the case. This is because when inflation is high, central banks raise interest rates to combat it. Higher interest rates are bad for gold because they enhance the opportunity cost of holding gold compared to interest-bearing assets or putting your money in a deposit account. On the other hand, lower inflation is usually good for gold because it lowers interest rates, making the dazzling metal a more viable investment alternative.
