NEW YORK (TheStreet) -- The U.K.’s inflation rate has turned negative for the first time since the 1960s, and Simon Smith, chief economist at FXPro, says that means the Bank of England will refrain from raising interest rates into 2016.
The U.K. government announced Tuesday that headline inflation fell 0.1% in April from a year before. Meanwhile, so-called core inflation, which excludes prices of more volatile items such as food and energy, fell to 0.8%.
"Bottom line, it’s certainly keeping rates on hold for the rest of the year and into early next year as well," Smith says, referring to U.K. interest rates.
Smith says it's important to look at the core inflation rate, which had been holding up.
"Even two months ago, the core rate was at 1.4%," he says. "That's fallen dramatically, so [it’s] now at 0.8%. it was at 1.0% the previous month. And that was the lynchpin of which Bank of England was saying, 'Look, you know, we’re seeing low headline inflation, but don't worry. Core inflation is still relatively firm, so there’s nothing to worry about.' And that story has changed.”
Smith says it's possible that some of downward price pressure in Tuesday's report might be unwound in May.
"A lot of it is around … air and transport fares that around the Easter period are quite volatile," he says. "I've noticed that before. So when we do see such falls in year-on-year terms we can see them reversed in the following month."
The latest news is worrisome for the Bank of England at a time when interest rates are already near zero and quantitative easing has already been done, Smith says.
"The Bank of England does have a headline inflation target: 2%, plus or minus 1%," Smith says. "It’s pinning on core inflation remaining relatively firm. And [softer core inflation] has been a temporary phenomenon, but if it becomes more entrenched, it does create issues for the bank and potentially more QE down the line."
Smith says the recent dollar reversal is not over yet. U.S. currency weakened this week on Federal Reserve comments suggesting the U.S. central bank may raise rates later than some had expected. (Higher interest rates tend to strengthen a currency against its counterparts, all else being equal.)
Smith says that even though U.K. interest rate hikes are now definitely on hold until 2016, the Fed likely will struggle to raise interest rates this year, and there's only so much strength the greenback can get from anticipation of higher U.S. interest rates.
In the short term, Smith says the dollar is likely to trade around 1.12 euros, but longer term, the euro could strengthen again.
Although, Tuesday's inflation news could cause the pound to weaken to 1.54 or 1.53 dollars in the short term, Smith reiterates that the U.K. currency will remain above the 1.50 level for some time, because the dollar's reversal is not finished.