Good week so far, FTSE rallied after UK inflation showed signs of cooling

Well, it’s been a pretty good week so far for the FTSE.

We like being the bearers of good news and today the FTSE rallied 2% after inflation showed signs of cooling.

We’ve been calling it for a while, and we have said on several occasions that if UK inflation shows any sign of dissipating, then there is a good rally ahead of us for the FTSE 100. The problem is, if you’re not in it, then by the time it happens….….you’ve missed it.

Figures this morning showed annual headline inflation in the UK of 7.9%, lower than a consensus forecast of 8.2% and down from 8.7% in May. Still high, but the monthly increase was only 0.1% which is something to celebrate.

Core CPI was 6.9%, also below an estimate that it would hold steady at 7.1%. Services inflation was also lower.

Consumer price inflation in the United Kingdom dropped to 7.9% in June, marking the lowest level since March 2022 and slightly below the market consensus of 8.2%, mainly due to a slump in fuel prices.

Additionally, the core rate, which excludes volatile items such as energy and food, eased to 6.9% from May's 31-year high of 7.%. Despite the recent slowdown, both rates remained well above the Bank of England's 2.0 % target, providing the central bank with room to continue the ongoing policy tightening campaign.

However, given that the month-over-month increase was only 0.1%, the Bank now have to be a little careful not to push the economy too far. The monthly increase needs to be between 0.1 and 0.2% for them to hit their annual target of 2%. If the number turns negative, then they will have to be even more cautious.

Transport prices declined 1.8% (vs 1.2% in May), driven by a 22.7% slump in the cost of fuels and lubricants. There were also notable downward effects from food and non-alcoholic beverages (17.3% vs 18.3%), furniture and household goods (6.5% vs 7.5%), and restaurants and hotels (9.5% vs 10.3%). Every month, consumer prices rose by only 0.1% in June as mentioned above.

Britain’s inflation rate dropped to the lowest in 15 months, fuelling hopes among investors and economists of a shift away from the worst price spiral in the Group of Seven nations.

Markets pared back bets for sharp increases in interest rates following the data, ruling out scenarios where the Bank of England would have to push borrowing costs near 7% by the end of this year.

We have always said that this won’t happen and that the market was wrong. The Bank will not push any further than is needed, and now time will fix the problem. The largest monthly increase last year was in October, so once this falls off the year-over-year figure, inflation will drop by around 2% in that month alone. Extremes are always the cause of problems, and if you can see the problem receding, move more cautiously.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, called the figures “a watershed moment.”

“We continue to think that the worst is over for UK households and that the MPC will not need to raise Bank Rate to 6.25%,” he said. It was priced in that rates would reach 6.5%. We don’t believe they will go above 5.5% but that is quite controversial many are simply looking at the annual year-over-year figure and not the rate of change.

Sunak has staked his economic reputation on halving the inflation rate by the end of the year ahead of a general election widely expected next year. If the monthly figure we saw today, continues through to the end of the year, then in December, annual inflation will be recorded as 3.9%. Inflation peaked at 11.1%, so the odds are currently with the Prime Minister, but who knows what will happen next?

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Britain remains an international outlier, with prices still rising almost four times the BOE’s 2% target in contrast to the US, where headline CPI has dipped back to 3%. However, Wednesday’s data brings the UK closer to international peers and even bucked a reacceleration in core prices seen in the eurozone in June.

The ONS said inflation was dragged down by falling prices for motor fuel and cooling grocery bills. Prices for food and non-alcoholic drinks climbed 17.3%, down from an 18.3% rise in May.

Inflation in restaurant and hotel prices also dropped to 9.5% from 10.3% in May, driven by the accommodation sector, in a sign that demand may be loosening, and wage pressures may be beginning to ease.

Most encouraging for the BOE were signs of domestically generated inflation beginning to ease. Core inflation — which strips out volatile food and energy prices — dropped for the first time in five months to 6.9% and there was also a cooling in services price increases, a measure the BOE has highlighted as important to its thinking. Inflation is set to fall even further in July’s data as the UK’s energy price cap limiting bills for households will fall.

The data caused sharp moves in markets that could relieve some of the pressure on homeowners after a surge in mortgage rates in recent months.

The market now sees the key rate peaking below 6%, down from as high as 6.5% priced earlier this month. The odds of a half-point hike in August — almost fully priced before the release — dropped to one in two.

Shares of U.K. housebuilders were as lower rates lead to lower borrowing costs which have a huge impact on the housing market.

Property firm British Land topped the Stoxx 600 index, rising by 10.5%. Property and investment business Derwent London was up by 10.09%, while housebuilders Persimmon and Barratt Developments were up by 9.11% and 6.79%, respectively.

“Sentiment surrounding housebuilders has been hinging on the direction of inflation and interest rates, and concerns that affordability is being sideswiped as mortgages become much more expensive, so any signs that homeowners might show more resilience is being welcomed,” said Susannah Streeter, head of money and markets at Hargreaves Lansdowne.

“Consumer discretionary stocks are also among the gainers, with JD Sports on the front foot, in the expectation that shoppers might still splash out on a new pair of trainers if mortgage outgoings or rents don’t rise quite so high as had been forecast,” she added.

European stocks were higher Wednesday after U.K. inflation came in cooler than expected.

The regional Stoxx 600 index climbed 0.39%, with financial services up 1.2%. The FTSE 100 was up close to 2% as the British pound fell against the U.S. dollar and the euro, and U.K. bond yields fell sharply.

In Europe, Dutch chip industry giant ASML nudged 0.5% higher after beating net profit forecasts, before sliding into negative territory in afternoon trading.

Stateside, Goldman Sachs reported a bigger-than-expected drop in second-quarter profits, after a bumper crop of big banking profits Tuesday. Netflix, Tesla, IBM and United Airlines will post earnings after the close.

So the story so far this week is that the FTSE has finally outperformed its peers. We are keen to see this continue while most of our traders are still long. Eyes in the US will continue to be earnings season which has so far, got off to a strong start.

Fears of weak earnings and a recession, forecast by Morgan Stanley have failed to materialise so far. If inflation keeps falling, and central banks are allowed to take their foot off the economic brakes, then we might all escape unscathed.

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