GBP/USD Plunges as Inflation Turns Negative

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The GBP/USD plunged around 200 pips on Tuesday, as UK inflation entered negative territory for the first time on record, supporting expectations for a prolonged period of rock bottom interest rates.

The GBP/USD bottomed out at 1.5448 on Tuesday after plunging 200 pips. The pair would subsequently consolidate at 1.5494 in the New York session, declining 160 pips. The pair faces initial support at 1.5460 – the so-called buy level – and resistance at 1.5800.

The GBP/USD climbed to new highs last week, as the post-election rally and a crumbling US dollar supported cable. The US dollar has been consolidating upward this week. On Tuesday the dollar index climbed 1.1 percent to 95.3 after staging a large rebound at the start of the week.

Underpinning the pound’s newfound weakness was a disappointing inflation report. Annual inflation in the UK turned negative in April for the first time on record, giving the Bank of England plenty of room in keeping interest rates at a record low of 0.5%.

Annual inflation was -0.1% in April after a flat reading in March, the Office for National Statistics reported on Tuesday. Economists forecast another flat reading for April.

Core CPI, which strips away volatile goods such as food and energy, advanced at an annual rate of 1.7%.

The BOE maintains that the fall inflation is transitory, suggesting that CPI will gradually return to target levels. BOE Governor Mark Carney has stated that inflation should begin turning higher later this year, eventually returning to the 2% target in the future.

A lower cost of living is a welcome sign for cash-strapped UK consumers, who are finally seeing wages appreciate faster than inflation. Average hourly earnings rose 1.9% annually in the three months through March, the ONS said last week. Excluding bonuses, average hourly earnings were up 2.2%.

In US data, housing starts surged in April, reaching the highest level in seven-and-a-half years. Housing starts rose 20.2% to a seasonally adjusted 1.135 million, the Department of Commerce said on Tuesday. That was well above forecasts calling for 1.02 million. Single family housing starts increased 16.7% to a seasonally adjusted 628,000.

Meanwhile, building permits rose 10.1% to a seasonally adjusted 1.143 million.