GBP/JPY outlook brightened amid sizzling hot UK inflation

The GBP/JPY has been among the top-performing major currency pairs today, as UK's 10%+ CPI reading has further widened the yield spread between UK and Japanese government bonds. Revived expectations that the Bank of England will now bump interest rates even higher and keep them there for longer caused gilt yields to rise, which in turn helped to keep the pound on the front-foot. As the yield spread between the UK and Japanese government bonds rise, this only helps to boost the GBP/JPY outlook.

• UK consumer inflation above 10% for 7 months
• Hot UK inflation send pound higher
• BoE rate hike bets rise

How high will UK interest rates rise?

This week’s higher-than-expected wage growth data and another double-digit inflation print have cemented expectations for even tighter monetary policy in the UK. The market is now betting that the Official Bank Rate will peak at 5% in September, up from the current 4.25% level. This implies there will be two more 25 basis point rate hikes, with the first one now highly likely pencilled in for May.

Unlike some other regions in the world where price pressures have eased markedly, UK’s nightmare with inflation continues. The persistency of price and wage growth is raising serious concern that wages and prices are feeding on each other over a sustained period. This wage-price spiral is raising fears that inflation expectations might become unanchored.

Pressure grows on BoE Governor Bailey

It is a tough pill to swallow if you are a member of the Monetary Policy Committee at the Bank of England. A lot of fingers will be pointed towards Governor Andrew Bailey. Critics would argue he was too slow to respond to the emerging inflation threat last year and that mistake continues to threaten his and BoE’s credibility. By taking their sweet time in raising interest rates, the MPC will now have to over-correct with further rate rises than they were previously planning. This is of course the last thing the economy needs right now, with household incomes being squeezed due to the cost-of-living crisis. Little wonder why everyone is going on strike.

The sticky inflation means workers will continue to demand for higher pay, putting pressure on businesses as well as government finances and services. We already saw some evidence of this in Tuesday’s employment report which showed nominal wages in the UK grew more than expected.

How bad was UK’s inflation data?

In short, super-bad. Headline CPI came in at double digits for the 7th consecutive month. While the 10.1% print for March was lower than 10.4% recorded the month before, it was still well above expectations. Core CPI inflation was also stronger than forecast, remaining unchanged at 6.2% and defying expectations of a fall to 6%.

Yen eases as BOJ seen unlikely to change YCC anytime soon

The new Bank of Japan Governor, Kazuo Ueda, has already mentioned that he will continue with the BOJ's current policy stance. While the rest of the other major central banks responded to soaring inflation by aggressively tightening their respective monetary policy stances, and some are still going at it (the BoE, for one), the BoJ let the yen slide instead by keeping its policy extraordinary loose. Now that global inflation seems to be on a downward path (except the UK, of course), and yen still a lot higher than where it was last year, the BoJ would feel even less obliged to change the yield curve control (YCC) settings.

This is putting upward pressure in the yield spread between the UK and Japanese government bonds, boosting the GBP/JPY outlook.

Source: TradingView.com

Any risks to the bullish GBP/JPY outlook?

Lots. The BoJ, for one, could do something unexpected, like remove its yield curve control policy. But that appears unlikely in the short-term. The potential for a stock market sell-off is always there, which could trigger haven flows into the yen. The only other one in this bullish GBP/JPY outlook that I can think of right now is if inflation proves too hot for the economy to handle, causing a severe recession and therefore triggers quicker-than-expected rate cutting from the BoE. This doesn’t appear to be a major concern for the market right now. However, it is something that could come back to haunt GBP bulls at some point.

GBP/JPY outlook: Technical Analysis

The slow-and-steady grind higher is precisely what would appease technical traders betting on a bullish outcome in the GBP/JPY outlook. Rates recently broke above key resistance around 166.00 and this level has now held firm on a daily closing basis on a number of occasions. Today’s hotter UK inflation data has triggered a move above the next area of resistance circa 166.85-167.00. This is now going to be the first line of defence for the bulls. They will need to hold this area on any short-term dips, if they want to see an eventual move towards and potentially beyond 170s.

Source: TradingView.com

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R