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Why Bitcoin Traders Should Care About Double-Digit Inflation in UK

source-logo  coindesk.com  + 1 more 17 August 2022 18:39, UTC

The cost of living in the U.K. surged to 10.1% in July, a government report showed Wednesday, providing the first instance of double-digit inflation in a major economy post-COVID-19 and presenting a fresh sign of price pressures spreading around the world.

The report could bring more urgency to economic discussions among crypto analysts, because inflation has underpinned a key bitcoin (BTC) market narrative for the past couple years.

John Silvia, a former chief economist for Wells Fargo who founded Dynamic Economic Strategy, said that faster inflation in the U.K. could exacerbate price pressures elsewhere, including in the U.S.

“There is a tussle between expectations of Federal Reserve and Bank of England policy,” he said.

The Bank of England has raised rates six times this year. August’s 50 basis point hike was the biggest increase since 1995. The U.K. central bank may raise interest rates faster as inflation is expected to hit 13% later this year, according to the bank’s own forecast.

Faster rate hikes by the BOE could increase demand for fixed-income investments in the U.K., which in turn could drive demand for the British pound, strengthening its value in foreign-exchange markets.

The flip side is that the U.S. dollar will be weaker by comparison, and so U.S. consumers may end up paying more for imports in dollar terms, which could add to domestic inflation. If the Fed were then forced to respond with more aggressive rate hikes, markets for risky assets would likely come under pressure.

Crypto assets are seen as one of the riskiest asset classes, and bitcoin traders have paid close attention to the inflation dynamics since at least early 2020.

Bitcoin was seen as a hedge against inflation because of its its preprogrammed pace of issuance under the original blockchain code. But in practice, actual reports of inflation have prompted central banks to slow down or reverse money printing and tighten monetary conditions to keep economies from running too hot, and that has put downward pressure on prices for risky assets, from stocks to cryptocurrencies.

“After the U.S. consumer price index came in a bit lower, the British pound appreciated in value,” Silvia said. “With the latest U.K. inflation, the pound may appreciate a bit more, especially if the Federal Reserve only raises the funds rate 50 basis points in September.” (A basis point is 0.01 percentage point.)

Interest rates in the U.K. are now at 1.75%, but traders are expecting borrowing costs to rise above 2% by year end and to exceed 2.6% by the end of 2023.

The U.S. federal-funds rate is at 2.25%, but markets have started pricing in less aggressive rate hikes in upcoming months. Minutes from the Federal Open Market Committee meeting in July, scheduled for release at 2 p.m. ET on Wednesday, could give markets more clarity on that.

While inflation in the U.K. is still on the rise, the U.S. economy has seen some relief, with the latest CPI showing signs of a slowdown in the rate of rising prices. The question is whether price increases are truly abating or whether the latest figure was a temporary reprieve. Another possibility is that prices will stay elevated around the current level.

“The rise in services inflation this year is a clear sign of inflation broadening and becoming self-reinforcing, and it’s been a pattern shared in both economies in the context of tight labor markets,” said Brian Coulton, chief economist at Fitch Ratings.

“This is arguably the segment of the CPI basket that the BOE has most control over, and it is way too high and still rising,” he said. “The recent U.S. CPI print showed a similar pattern.”

coindesk.com

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