Pound hits one-year high as CPI data boost rate-hike odds

London - The pound rose to a one-year high against the dollar after UK inflation accelerated more than forecast, prompting investors to bring forward expectations for an interest-rate increase by the Bank of England (BoE) next year.

Sterling strengthened against all of its Group-of-10 counterparts after UK legislation to withdraw Britain from the European Union passed its first parliamentary hurdle, and data showed consumer prices rose an annual 2.9% in August. That was more than the 2.8% median economist estimate in a Bloomberg survey and July’s 2.6% reading.

The release comes as BOE officials meet ahead of their policy decision on Thursday. While the Monetary Policy Committee is seen holding its key interest rate at a record-low 0.25% this week, rate markets are now pricing in a one-in-three chance of a rise by the end of the year, compared with one-in-five a week ago.

Money markets are pricing a full 25-basis-point rise for its August 2018 meeting, based on Sonia fixings.

The inflation data “are going to continue providing support to the pound ahead of the BoE this Thursday,” said Stephen Gallo, an analyst at BMO Capital Markets. “While not good for the UK consumer, sterling positioning is still short, the dollar is weak and these numbers could have a material impact on the tone of the MPC discussions.”

The pound strengthened as much as 0.9% to $1.3282, touching its highest since September 15, 2016. It rose as much as 0.9% against the euro, gaining for a third day.

Hawkish hopes

Expectations for the BoE to hike rates at this week’s meeting are low, according to interest-rate futures, which show just a 7% probability of an increase, up from 5.3% before the data.

The pound’s 11% drop against the dollar since the Brexit referendum is feeding through to prices for household items, with inflation never higher since 2012.

“We were expecting continued deceleration of price pressures into year-end, but pass-through from the weaker sterling may be having lingering effects here,” said Gallo. Every single category increased from July, “with transport, communication, household goods and clothing all showing material increases.”

After the data, a flurry of activity occurred in short-sterling options that would pay off if the bank raises rates at this week’s meeting.

Sterling had already risen ahead of the data on expectations of the BOE to turn more hawkish, according to Rabobank’s Jane Foley. Just two of the nine members of the committee voted to increase interest rates last month, but some economists see a third - Andy Haldane - joining them at this meeting.

“Some re-adjustment of positions has been taking place in sterling in case Haldane comes out as a hawk this month,” Foley said.

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