Brexit risk and UK inflation outlook - MUFG

Lee Hardman, Currency Analyst at MUFG, notes that the pound has strengthened in the Asian trading session in part supported by the perception that Brexit risk has eased a little, although the bigger picture remains that it has been consolidating at lower levels in recent months after the sharp adjustment lower earlier this year.

Key Quotes

“The release of the latest ICM polls released yesterday continued to reveal a marked divergence in results between the online and phone polls. The ICM online poll revealed that 47% of respondents wanted to leave the EU compared to 43% who wanted to remain. In contrast, the ICM phone poll revealed that 47% of respondents wanted to remain in the EU compared to 39% who wanted to leave.

A recent Populus study found in their assessment that “the true state of public opinion likely lies between the online and phone polls, but closer to phone, approximately two thirds of the way towards the leads phone polls are on average giving Remain while, of course current methodologies are unchanged”. It is now a widely held view which places greater significance on the still more sizeable lead for support to remain within the EU in the phone polls.

The UK bookmakers have also been adjusting their odds to signal an even lower probability of Brexit. Ladbrokes stated yesterday that over 90% of the money staked was for the UK to remain in the EU for the fourth consecutive week. The latest betting odds see only around a 25/30% probability of Brexit. It appears very roughly consistent with the current pricing of cable. If we assume that that cable could rise to 1.5000 on a vote to remain and fall towards 1.3000 in the event of Brexit, the current value at around the 1.4500-level is roughly discounting five big figures of Brexit risk (5/20=25%). We are not as confident that the UK will vote to remain within the EU attaching a higher probability to the risk of Brexit at around 35-40%.

The other main focus in the UK today will be the release of the latest CPI report for April although it is likely to have only a limited impact on the pound. The report is likely to reveal that headline inflation pressures remain subdued in the near-term. Core inflation pressures have been gradually firming since the middle of last year.

Headline inflation is likely to accelerate more sharply back towards the Bank of England’s target in the second half of this year if the rebound in the price of crude oil is sustained. Higher inflation appears likely in the year ahead if the UK remains in the EU or votes to leave. A more marked acceleration in inflation would be likely in the event of Brexit as the trade-weighted pound should decline sharply.”