Markets dislike uncertainty, and that is the only certainty in the markets right now – this seems to typify market action over the past few days, as we head towards the end of a topsy-turvy week.
Sterling has had a rather unimpressive day, falling sharply against its counterparts on the back of a broad rise in risk aversion. A spike in the price of oil as tensions mount in the oil rich Middle East and North Africa is driving investors to safe haven currencies with the Japanese yen and the Swiss franc the outperformers at present.
The pound has rallied since the start of 2011 on the back of higher inflation and heightened speculation that the BoE will raise rates sooner than most. However, it seems that after the release of yesterdays minutes investors may well be reassessing the state of the UK economy and asking themselves whether monetary tightening will threaten the UK economy’s fragile recovery.
Arch hawk Andrew Sentance is certainly of the opinion that raising interest rates is the way forward, as was detailed in my recent blog post. The increased hawkishness in the MPC camp, led by Sentance, has been supportive for the pound in recent times, however he is due to leave the MPC in May. So what effect will this departure have on the BoE’s stance? Vicky Pryce, one of the candidates to succeed him, pointed out the risks of raising rates too soon in a column this week – this won’t sit too well with investors who have already priced in an imminent rate hike.
David Miles also added to sterling’s woes in the short term, announcing yesterday evening that the best way to control inflation would be to “raise interest rates gradually,” contradicting Sentance’s argument that there should be an immediate rise of 0.5% in the base rate.
Uncertainty over the prospects for the UK economy and the evident dilemma facing the Bank of England looks set to keep sterling choppy. We will now look forward to the GDP revision tomorrow morning (first estimate -0.5%) – something tells me that we will be in for a rather underwhelming figure. Even a small upward revision would still leave the economy in contractionary territory, and is unlikely to prove the catalyst for renewed sterling strength.
Edward Knox
Analyst - Caxton FX
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