GBP Disinflation Persists as Sentiment Remains Weak

Examining recent data from the UK, it becomes increasingly apparent that the prevailing disinflationary trend is poised to persist, notably underscored by the latest insights from the BRC shop price data. From my perspective, the significant drop in food inflation is a notable development, as the annual rate dipped from 7.6% to 6.6%. This marks the eighth consecutive decline and brings the rate to its lowest point since June 2022. While the journey back to pre-COVID levels is ongoing, the impact on shaping lower inflation expectations among households cannot be understated.

Delving deeper into the BRC release, a noteworthy observation is the robust nature of food promotions during the Christmas period, reaching their strongest levels in four years. This evidence suggests an emerging trend of increased price sensitivity among UK households, a factor that could play a pivotal role in influencing consumer behaviour in the coming months. As we eagerly await the official data release on January 17th, it is highly likely that the BRC data will be corroborated by the ONS data, further reinforcing the narrative of a continued easing of food inflation.

In my analysis of the broader economic landscape, the overall data compellingly points towards a consistent trend of alleviating inflationary risks. The 6-month annualized rate in the UK, up to November, has dwindled to a mere 0.6%, while the core rate stands at a relatively modest 2.4%. The pace at which inflation rates are receding now appears to be nearly as swift as their initial ascent, potentially contributing to a more stable economic environment.

However, today's revelations from the Institute of Directors paint a contrasting picture, indicating that the marked deceleration in inflation has not translated into a boost in sentiment. Personally, I find it concerning that the IoD's Economic Confidence Index dropped from -21 in November to -28 in December. Such a decline underscores the mounting fears of a recession, which, in turn, have a detrimental effect on confidence levels among senior business executives. The modest contraction of -0.1% in Q3 real GDP growth has been exacerbated by a more substantial -0.3% drop in October, thereby amplifying the risks of a technical recession.

Furthermore, consumer sentiment remains a cause for concern. Although the GfK Consumer Confidence Index showed a slight improvement, rising to -25.1 in January, it still hovers closer to the cyclical low of -42.8 than the pre-inflation shocks high of +1.0 recorded in November 2021. This disparity suggests that despite easing inflation, the broader economic uncertainties continue to weigh on the mindset of consumers.

Despite these economic headwinds, it appears that the Bank of England is poised to maintain its current monetary policy stance in the near term. Any substantive shift in focus from potential rate hikes to rate cuts would likely hinge on a more pronounced decline in wage growth. The current economic landscape suggests that such a shift may not materialize imminently.

Notably, amidst these economic complexities, the pound experienced a decline alongside all G10 currencies yesterday. However, it displayed notable resilience against the euro. EUR/GBP, for instance, failed to sustain levels above the 0.8700-level, a trend that piques my interest. Considering the policy divergence compared to the European Central Bank (ECB), this should provide additional support for the pound against currencies other than the dollar. These nuanced dynamics within the foreign exchange market add an additional layer of complexity to the unfolding economic narrative, hinting at the intricate dance between economic indicators and market sentiment.

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