UK PPI Input (YoY) (SEP) (4:30 ET; 8:30 GMT)
Expected: 4.4%
Previous: 0.6%

UK PPI Output (YoY) (SEP) (4:30 ET; 8:30 GMT)
Expected: 2.9%
Previous: 2.5%

How Will The Markets React?

After oil prices hit a record high in September and other commodities rallied significantly, UK producer price data for the month of are expected to surge higher. The data could signal that inflation pressures are building up rapidly in the country, which could severely limit the ability of the Bank of England to cut rates this year. Indeed, after troubled mortgage lender Northern Rock sought emergency funding from the central bank and experienced an all-out bank run by depositors, fears that a credit crunch would impact the UK economy were only exacerbated after the BOE referenced the disruptions in the financial markets in an unexpected policy statement following their September 6 rate announcement. However, the BOE did not cite the conditions of the financial markets or issue any policy statement following their October 4 rate announcement, suggesting that they have no plans to address these credit issues with the overnight lending rate. Nevertheless, the release of the minutes from this meeting on October 17 could prove to be crucial for the outlook for interest rates in the UK. If the minutes show even a few votes for a rate cut by some of the monetary policy committee members, the markets may judge that the doves in the Bank of England will garner enough votes to actually enact more accommodative policy in November or December. As a result, the British Pound could continue to build upon its recent gains as interest rate differentials continue to work in favor of the currency.

Bonds – Long Gilt Futures

Gilts came close to collapse on the US NFP data, but the contract continues to hold up well with an impressive bounce that has taken things back to the 107.50 barrier. Daily charts remain somewhat bullish as the 50 percent retracement level at 106.96 halted this morning’s slide. However, a potential head and shoulders pattern could find Gilts falling lower, especially if strong UK PPI data on Monday morning suggests that the Bank of England has little room to cut rates this year. If PPI is even stronger than expected, the contracts could fall back towards 106.50.

FX – GBP/USD

The Cable rally has gone on to test the 2.0450 level on Friday, as the British pound was propelled higher on Thursday after the Bank of England did not issue a policy statement, signaling that they have no plans to address the issues lingering in the UK financial markets with an adjustment to the overnight lending rate. Nevertheless, with the housing market and consumption growth likely to take a hit later in the year, there is debate as to whether the central bank will try to be proactive and reduce rates before economic data starts to deteriorate significantly. However, with inflation generally the Bank of England’s predominant concern, a rebound in CPI above the bank’s 2.0 percent target could nip any speculation of a rate cut in the bud. Furthermore, the release of the producer price index for the month of September could be the first clue into how inflation figures will fare in coming months. Both the annualized input and output index readings are anticipated to surge, which could send Cable breakthrough resistance to take on 2.0500, with sharper rallies going on to target 2.0650. However, if the data proves to be somewhat disappointing, or if the concurrent release of UK industrial production shows a marked decline, GBP/USD could drop down to 2.0350.

Equities – FTSE 100 Index

The FTSE 100 index has staged a consistent rebound after bottoming out at a 5821.70 on August 17, but the uptrend may be clipped at resistance at 6,600 if Monday’s UK PPI data prints in line with forecasts. Concerns over inflation were eased after Bank of England’s preferred inflation gauge, consumer price index, declined to a one-year low below the central bank’s target of 2.0 percent in August. However, the Bank of England may be forced to refocus on price stability if PPI data suggests that consumer prices may face increasing pressure from the economy’s production side. As a result, ramped-up speculation of further monetary tightening by the Bank of England may force the FTSE 100 to lose its upbeat momentum, which has been felt globally after the US Federal Reserve’s rate cuts on September 18.

Terri Belkas is a Currency Strategist at FXCM.