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The Pound could experience some heightened volatility against the U.S. Dollar on Tuesday as foreign exchange traders take a cue from U.S. inflation data.
Inflation numbers are of heightened importance at the present time as they feed directly into how the Federal Reserve (Fed) approaches the tricky question of when to raise interest rates.
The rule-of-thumb being that higher inflation readings increase pressure on the Fed to consider raising interest rates, which are in turn ulimately supportive of the Dollar.
"US CPI inflation data... may prove moderately USD negative should they reveal that the acceleration in price pressure seen in the past months started losing momentum in June, which we expect," says Roberto Mialich, FX Strategist at UniCredit Bank in Milan.
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The market is looking for a reading of 0.5% month-on-month for June, a shade softer than the 0.6% reading from May.
The annual figure is expected to come in at 4.9%, just below the 5.0% reading for May.
Ahead of the release the Pound-to-Dollar exchange rate (GBP/USD) is trading flat in calm markets at 1.3887 and the Euro-Dollar rate at 1.1865.
"Markets appeared somewhat directionless yesterday, amid lack of significant news and as the summer lull gradually sets in. CPI data from the US could change that today, but it likely takes a rather big surprise for these numbers to have a material market impact," says analyst Ingvild Borgen at DNB Bank ASA.
Foreign exchange analysts say the 'base effect' is likely to mean inflation in the U.S. is at a high-water mark (the base effect is where current data is flattered by the comparison to the unusually sizeable slump in data a year prior, owing to lockdowns).
The Fed expects the current spike of inflation to be transitory and they therefore see it falling over coming months, arguing that it is no reason to rush into a rate hike cycle.
That said, the June FOMC meeting reveals policy makers are becoming increasingly concerned that inflation does prove more durable.
"We are less interested in when the peak is and much more interested in how enduring price pressures are likely to be. So, we have no doubt that this 'peak' narrative is likely to be all the talk on Tuesday," says Elsa Lignos, Global Head of FX Strategy at RBC Capital Markets.
The inflation numbers come ahead of the mid-week testimony of the U.S. Federal Reserve Governor Jerome Powell before Congress.
The testimony will shed further light on how the Fed is approaching current economic data and could therefore yet prove to be the highlight of the week for the Dollar.