Core inflation in the UK rose by 1.4% year-on-year, slightly faster than the market expectation of 1.3%. The pound rebounded from the intra-day low of 1.3172 against the US dollar on the back of the solid inflation report, yet slipped rapidly back below the 1.32 mark.
The consumer prices remain comfortably below the Bank of England’s (BoE) 2% inflation target. Hence, the stronger-than-expected inflation read should have a limited impact on the mid-term bearish view on the pound, which trades with a strong negative skew given that the expectation of a rate cut toward 0% has become the base case scenario.
As of today, the market assesses a 83% probability for an August rate cut and nearly a 90% probability for a December cut.
The FTSE opened in the red as British manufacturers’ confidence regarding the future of their businesses declined to a two-year low following country’s decision to leave the European Union. The scope for lower rates is yet insufficient to cheer up FTSE investors.
Financials are under pressure on the expectation that lower UK rates could further squeeze profit margins and deteriorate earnings despite the sharp cost cutting program across the industry.
The manoeuvre margin in the banking sector narrows as the benefits from lower costs could gradually become insufficient to counterbalance the costs of operating in the challenging low rate environment. The weak earnings from the US banks also dent investors’ appetite in the UK’s banking sector.
Some colour out of Turkey
Moody’s warned that Turkey could lose its investment grade rating due to high political risks. The rating agency also highlighted the risks of accelerated capital outflows and a rapid decline in currency reserves.
In the worst case scenario, Turkey could also face a crisis in its balance of payments, according to Moody’s analysts. S&P and Fitch also warned of a potential deterioration in Turkey’s sovereign rating pointing at a potential divergence in political opinions and the fragile base regarding the institutional independence.
As concerns regarding the institutional independence are heating up, the Central Bank of Turkey’s (CBT) rate decision will be in focus. The CBT is expected to cut the overnight lending rate by 25 basis points, versus 50 basis points presumed before Friday’s coup attempt.
The sovereign yield curve surged by 75 basis points on the front-end, and by 100 basis points over 10 year maturity, suggesting that a smaller rate cut in the upper corridor could trigger a short-term rally in the lira, nevertheless the upside is expected to remain limited.
Lower policy rates could be perceived as a mispricing in Turkey’s risk-to-return ratio given the upside shift in sovereign rates. Therefore, the market is expected to remain on the sell side in the lira market. The USD/TRY is an interesting buy-the-dip to strengthen the short lira exposure in light of fundamental, political and financial risks.