The latest UK inflation data shows a tough situation. Initially, there were low expectations for an interest rate cut next month. Now, the chances of any cuts this year seem to be decreasing even more. Increased transport costs, driven by higher airfares and hotel prices, have significantly contributed to rising prices. The ONS suggests this trend may be linked to the school summer holidays. Additionally, core annual services inflation jumped from 4.7% in June to 5.0% in July, raising concerns.

Rising Food Price Inflation

Food price inflation also rose to 4.9% in July, up from 4.5% in June, marking the largest increase since February of last year. These changes could lead the markets to lower their expectations for interest rate cuts this year. The data hints at potential stagflation risks for the Bank of England as the year continues. The recent UK inflation rate is at 3.5%, well above the 2% target. This puts the Bank of England in a tough spot. The market is quickly losing confidence in rate cuts for 2025, making December SONIA futures appealing to sell. This stubborn inflation echoes the challenges seen in 2023, where controlling prices was much harder than expected. This situation could benefit the pound, especially against currencies from central banks that are more cautious. The European Central Bank has already made two cuts of 25 basis points this year, creating a clear difference in policy. We are considering long GBP/EUR positions or buying call options on sterling to take advantage of this interest rate gap.

Classic Stagflation Scenario

The mix of ongoing inflation and high borrowing costs is a typical sign of stagflation, which usually harms stock prices. This comes after last week’s preliminary Q2 GDP data showed only a 0.1% growth, indicating economic distress. Therefore, we are looking at buying put options on the FTSE 250 index, as its UK-focused companies are more at risk during a slowdown. Uncertainty about what the Bank of England will do next is likely to keep market volatility high in the upcoming weeks. The implied volatility on one-month GBP/USD options has already surged to a two-month high after the inflation report. This situation suggests that long volatility strategies, like a simple straddle on the pound, could be profitable no matter which way the currency moves. Create your live VT Markets account and start trading now.

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