Domestic data to confirm BoE's cautious stance

UK CPI inflation (Tuesday) is expected to show a print of -0.1% m/m (consensus 0.0% m/m) in September, following a flat reading in August. On Wednesday, labour market data will be released. Unemployment in August is expected to remain at 5.5% as job creation continues to slow, while average weekly earnings could maintain its pace of growth at 2.9% 3m/y, with core earnings strengthening further to 3.0% 3m/y after 2.9% 3m/y in the previous month.

UK inflation and labour market data are unlikely to alter the BoE's cautious policy stance and the bearish GBPUSD view. Last week's BoE minutes revealed a greater degree of concern by the MPC about the UK inflation outlook given recent mixed domestic data and deteriorating global growth prospects. The minutes highlighted that "the near-term outlook for CPI inflation appeared slightly weaker than at the time of the August Inflation Report" and that inflation was now "likely to remain below 1% until spring 2016", encouraging the view that the BoE is a long way from tightening policy. The MPC added that "although the exchange rate had depreciated slightly since the August Inflation Report, its substantial appreciation since mid-2013 continued to depress import price growth and so CPI inflation".

GBP is expected to outperform the EUR due to a significant growth differential, but headwinds should push cable lower over the coming year. UK economic growth remains relatively robust, but fiscal consolidation will likely weigh on UK activity in an environment of surprisingly low inflation and the underpriced impending EU referendum. Indeed, recent referendum polls show the in-out gap has now completely closed, with some polls showing greater support for the UK to exit the EU. 

GBP options, however, suggest a risk premium for the event has yet to be fully priced. All of these measures remain low relative to recent history and much lower than the highs reached in the lead-up to previous political events such as the September 2014 Scottish referendum and the May 2015 general election. 

"Our recent Global Macro Survey shows most investors think the referendum is an event risk, with roughly half believing it will lead to GBP weakness and half thinking it will simply increase volatility. About one-third of respondents, however, think the effect will not likely be seen until the government announces a date and question wording", notes Barclays.