Sterling falls back after consumer prices drop

Sterling sank below $1.56 on Tuesday, hitting a one-week low as the dollar rebounded and data showed UK consumer prices fell last month from a year ago, the first annual decline since 1960. Two days of gains for the dollar, on its worst run in four years since mid-April, have curbed a rally for sterling that followed a victory for Prime Minister David Cameron's Conservatives at elections on May 7.
The market broadly favours Cameron, but his promise to further cut public spending holds risks for economic growth and may further delay any rise in domestic interest rates.
The fall in consumer prices - a 0.1 percent decline versus forecasts for no change - bolstered expectations the Bank of England will hold off raising rates until well into next year.
"Pretty disappointing numbers, and they are a negative for sterling for sure," said Alvin Tan, a strategist with Societe Generale in London.
The pound also retreated against the euro following the data but remained in positive territory, up almost half a percent on the day at 71.88 pence per euro.
"Today's reaction was more about a stronger dollar than a weaker pound," said Soeren Hettler, a currency analyst with Germany's DZ Bank in Frankfurt. "The dollar has taken some of the heat out of the moves of the last days and weeks and that has had an impact on cable (dollar/sterling)," he added.
By late afternoon in London, the pound had lost 0.9 percent to trade at $1.5515. Overall, the outlook for the UK economy remains better than expectations for its European peers. Retail sales numbers later in the week may swing the focus back in that direction.
Jake Trask, a corporate dealer at online retail broker UKForex, argued that a short spell of deflation would help consumer spending power after years of below-inflation pay rises.
He said that once last year's big tumble in oil prices fell out of the annual numbers later this year, inflation would pick up and the BoE would be able to raise rates early in 2016. Others are less sure.
"The Bank of England will not move before the middle of next year," Hettler said. "There was a discussion last week about an earlier timescale, but if we look at the inflation rates I don't think that is justified."