PPI Inputs (OCT) (09:30 GMT, 04:30 EST) PPI Output (OCT) (09:30 GMT, 04:30 EST)
Actual: -0.1% Actual: 0.3%
Expected: -0.5% Expected: 0.1%
Previous: -1.9% Previous: 0.2% (R)
How Did the Markets React?
The British markets had their first taste of inflation following the Bank of Englands largely expected rate last week. Generally, inflation gauges that hit the newswires just after a central banks rate decision are met with little fanfare as the market has already found its assessment of policy through the actual rates themselves. However, with the possibility of another rate hike by the first quarter of next year still finding a lot of interest among speculators, price gauges may find an added level of interest through the end of the year. Todays producer prices offer the first true report of inflation for the month of October. While input prices did slightly better than expected, the real interest laid in the output numbers. Prices received at the factory gate rose at their slowest annual pace in over two years with the 1.7 percent headline growth. This was the number the currency honed into to suggest to traders that any potential in a December rate hike was completely off the radar. On the other hand, the more skittish equities market took the huge jump in the annual core number from 2.0 percent to 2.5 percent to mean that there was more than enough risk in betting against the MPCs intentions going ahead. Given the cross market reaction to this typically less market-moving inflation report, volatility following the CPI, RPI and BoE quarterly inflation reports due later this week could be substantial.
Bonds UK 10-Year Gilts
While equities plunged on fear that risk of a rate hike was too high and the pound dropped with predictions that a pass was the inevitable outcome in December, gilts were hardly responsive to todays inflation reports. The mixed sentiment between the slower than expected headline number and better than expected core report left debt investors unsure of whether this report was enough to put the MPC on track for another rate hike. In the minutes following the report, the benchmark gilt fell 4 basis points 95.95. However, after North American liquidity started to come online, the risk adverse among the crowd triggered a large slide that measured 33 basis points and lasted throughout the afternoon in London. The change of heart was most likely a precautionary step in discounting debt in the event that the number of inflation reports due later this week could be singularly in support of another rate hike.
FX GBP/USD
Despite relatively motionless domestic bond prices, the British Pound posted sharp declines following the mornings inflation report. The GBPUSD continued previous weakness to retest the psychologically significant 1.9000 mark, as traders showed a fairly clear GBP-bearish bias on the news. Currency markets honed in on the fact that headline output figures grew at the slowest pace since early 2004, but ignored Core Output price growth at the highest since July. This is likely due to the fact that Bank of England officials have made it relatively clear that price targets are aimed at controlling overall price levels?including volatile food and energy costs. As such, todays report suggests that October inflation data may effectively rule out further BoE interest rate hikes by year-end. It serves to mention, however, the GBPUSD resilience at the 1.9000 mark suggests that currency traders have not yet thrown in the towel. Markets will wait for remaining CPI and RPI data to gauge the likelihood of higher rates in 2006.
Equities FTSE 100 Index
Equities declined through early London trading, underlining apparent risk aversion in UK stock markets. The FTSE 100 nearly mirrored the GBPUSD, falling through the US open before staging a retracement by the European close. It seems that speculators paid closest attention to the fact that Core Output prices remained well-above the overall 2 percent inflation target and largely discounted the falling headline result. The divergence between cross-market reactions suggest that a correction is likely to occur in one or both markets, however, as the coming days of data may change overall outlook on the future of BoE interest rates. Perhaps most significantly, tomorrows CPI release is expected to show year-on-year inflation at 2.6 percent?the highest growth since 1996. If this occurs, we could see further declines in the UKs FTSE 100, while the currency could continue its recent reversal to retest 19-month highs. It will be important to monitor the reactions across asset classes, as diverging price movement may actually predict corrections across currencies, bonds, and equity markets.
