Uncertainty Over UK Monetary Policy At Fever Pitch

Yesterday certainly felt like an outright war on the foreign exchange markets, mostly reflecting a high degree of uncertainty over a potential cut in the Bank of England base rate today, which, if enacted will take rates to their lowest level since the Bank was founded to fund war with the French in 1694.  It is certainly appropriate then that yesterday saw a continue of Tuesday’s rally against the Euro which saw GBP/EUR soar up into the 1.11 level as investors mused that the currency may be somewhat undervalued in current conditions.  GBP/USD also saw a beefy bounce yesterday up to the 1.52 level as the Pound was bought outright with the Dollar being sold off across the board.

Sterling may well have been undervalued against the Euro over the last few weeks as dark winter days closed in and traders actually began to believe Jean-Claude Trichet of the ECB as he blustered that the Eurozone was at little comparative risk of deflation when looking at the apparent monster of inflationary forces.  Now, even with Alastair Darling nervously darting into public view yesterday to confirm to us that the downturn is ‘far from over’ for the UK, the Pound looks better against a Euro which will surely suffer from loss of yield appeal over the next quarter.  Even if the economic recovery of late-2009 which our Finance Minister so boldly prophesied last month does not come to pass there is a general view now that Europe is lagging well behind on monetary policy measures.

However, despite our clear and consistent criticism of the Europeans, things turned a little scary on the US front yesterday, casting fresh doubt on the ability of the American economy to make a relatively rapid return to growth.  EUR/USD certainly showed the strain on the Dollar side, jumping to 1.37 on the unpleasant reading of last month’s Federal Reserve meeting which indicated that interest rates may be lower for longer than may have been guessed.  The minutes essentially showed that Federal Reserve members are now united in their desire to print money and purchase private assets over the long-term in order to keep Treasury yields low and stimulate inflation as their economy risks a devastating decrease in prices.  Investors took considerable fright at this owing the gist of the minutes pointing to a disbelief in the return of natural inflation for some time to come, thereby keeping yields extremely low on US debt.

Turning to today, there is definite potential for some fireworks on foreign exchange and money markets as observers wait with bated breath to see how the Bank of England is reading the current economic situation from the monetary policy front.  Currently the Bank is expected to cut by 50bp, but this is by no means a sure thing and a degree of Sterling’s moves yesterday are reflecting the potential for the MPC to cut by more, less or even nothing.  Most likely though is that the cut will be at 50bp and GBP/EUR and GBP/USD will remain resilient ahead of US Unemployment Claims in the afternoon weighing on the Dollar in the short term.