High UK inflation figure stokes expectations for a rate rise

Publication date: 16 February 2011
Author: Duncan Higgins, CaxtonFX

The pound was the on form currency once again yesterday, rising across the board as a high UK inflation figure stoked expectations for a rate rise. In line with forecasts, official data showed consumer price inflation rose to 4.0% in January, double the BoE’s target rate. The hawkish arguments of the Monetary Policy Committee are certainly gaining credence, which is lifting demand for sterling.

It’s another busy calendar today with the Bank of England’s (BoE) Inflation Report and the minutes to the Fed’s latest meeting the two stand-out announcements. The BoE’s report is expected to be relatively hawkish and revise up near-term inflation projections, which could further boost expectations that interest rates will rise soon. However, to a large extent this expectation has now been priced in and the market may want to wait until next week’s MPC minutes before giving the pound a run higher.

STERLING/EURO:

Sterling got close to a one-month high yesterday as investors continue to bring forward their expectation of a near term rate rise.

Data showed UK inflation remaining stubbornly high, fuelling speculation that the Bank of England will seek to contain price pressures. This speculation was buoyed further as Mervyn King’s explanatory letter to the Chancellor (which he’s required to write when inflation is outside of the target range) was read by the market to have quite a hawkish tone.

However, in trading this morning the pound has come away from its highs, dropping back to 1.19 with the market a little apprehensive ahead of the Inflation Report.

The minutes next week are also likely to reveal the differing views on the MPC Committee about the balance of risks. The majority of the members still want to see evidence that the economy can weather the storm of austerity measures before shifting their policy stance. Even with inflation at its current level, we’re unlikely to see a third vote in favour of a rate rise just yet.

The latest UK claimant count figures are also due today at 09:30 (as is the overall unemployment rate) but the data is likely to struggle for attention ahead of the Inflation Report. A significant monthly change would be needed to even register with investors.

STERLING/US DOLLAR:

The pound gained near a cent against the US dollar yesterday, and is continuing to make up ground this morning ahead of the BoE’s key report.

The pound has gained nearly 3.5% this year against the greenback, as persistently high inflation has fuelled expectations that interest rates will rise in the near term.

The US dollar came under a little pressure in the afternoon after the release of US retail sales data, which showed sales figures below expectations in January.

This morning the price has risen to $1.6150 but upside momentum could be capped here in the short term. Mervyn King’s comments are likely to mirror what the inflation letter said yesterday, restricting the Report’s impact. In addition, there are still evident fears about the impact of a rate rise on the economy, which may limit sterling’s upside.

The other key announcement today is the release of the Fed’s minute, but these are not due until 19:00 so price action may have to wait until tomorrow. With no imminent sign of pressure to lift the base interest rate it’s the Fed’s QEII programme that will be in focus. Any hint from the hawkish committee members that they’re looking to withdraw stimulus early would be positive for the dollar but there have been few signals of such a move.

EURO/US DOLLAR:

The euro closed virtually unchanged against the dollar yesterday, retreating from early gains as eurozone debt concerns weigh.

Rising levels of risk appetite put the US currency broadly on the back foot yesterday, but the single currency had its gains steadily reined in amid ongoing eurozone concerns.

Following on from disappointing GDP figures from the core eurozone countries, a monthly consumer sentiment survey from Germany also failed to meet expectations.

Adding to concerns, comments from the Portuguese central bank noted that the country is still in recession as the budget deficit reduction policy measures take effect.

However, the dollar has again conceded ground this morning, leaving the price at $1.3550. Data yesterday afternoon showed that US retail sales rose less than expected in January, rising just 0.3%, the smallest gain since a drop in June and providing further evidence that the Fed will keep policy unchanged.

With the Fed’s minutes now in focus the single currency could have further to gain in the near term but we doubt the rally will prove sustainable.

STERLING/AUSTRALIAN DOLLAR:

In line with the pound’s broader movement it rallied strongly against the Australian dollar, climbing nearly two cents.

Sterling matched its highest point since January 24th at 1.6214 off the back of improved sentiment toward sterling. High inflation has brought forward UK interest rate expectations whereas the market has priced out pretty much any chance of a rate hike in Australia in the coming months.

However, the aussie has pared its losses this morning despite the news that Moody’s Investors Service had placed on review for possible downgrade the ratings of four major banks.

A broader weaker US currency has led to gains for the aussie, leaving the price back down at 1.6150.

There is little data from Australia due in the short term, which should leave risk appetite to dictate direction.

STERLING/NEW ZEALAND DOLLAR:

Sterling’s run against the kiwi yesterday was consistent with its run across the board, climbing to its highest point since early October on interest rate expectations.

Sentiment toward the kiwi has soured in recent sessions due to weak economic data, which has enabled the pound to climb over 3% in the last week.

The New Zealand dollar was further hurt overnight by a survey suggesting the economy probably slipped back into recession in the fourth quarter on cautious consumers, a weak housing market and the fragile labour market.

The pound is currently sitting at 2.14, slightly lower on the day but with expectations for the price to move higher in the short term.

STERLING/CANADIAN DOLLAR:

The pound’s two day rally has stalled this morning having approached 1.60 yesterday on improved sentiment toward the UK currency.

The Canadian dollar also came under selling pressure as a disappointing reading of US retail sales and a decline in US stocks.

Oil prices have also exerted a bit of downward pressure on the CAD, pulling back from recent highs as fears over Middle East unrest ease.

Having seen heightened volatility between this pair in recent sessions, we expect that the price could settle back into its familiar range around 1.60 with few Canadian economic announcements due and sterling’s upward momentum seemingly running out of steam.

Digg Digg