UK inflation prolongs sterling’s weakness
Hopes for a near-term BoE interest rate rise were dashed last Tuesday as UK headline inflation surprisingly eased from 4.4% to 4.0%. The unexpected drop has releived the pressure on the MPC to tighten monetary policy to combat inflation levels that are still double the BoE’s target. Whilst enjoying a minor resurgence at the end of last week, sterling remains broadly out of favour with expectations of a BoE rate rise now pushed back from August to October. A couple of weeks ago, many major players were betting on a May rate rise!
This contrasts with expectations for a further eurozone rate rise in July, following a steady flow of hawkish ECB rhetoric. Meanwhile, the US Federal Reserve remains well behind the curve in terms of interest rate hikes, which along with the ongoing ‘QEII’ programme, is almost wholly responsible for the US dollar’s continuing weakness. The dollar is the weakest currency out there after the yen, nobody wants to hold it. Last week’s poor data from the US labour market, the Fed’s most pressing concern, did little to improve the dollar’s long-term prospects.
Euro still strong but struggling for further momentum
Towards the end of last week, the euro failed to extend gains as peripheral debt issues finally started to weigh. Uncertainty has sprung up around a possible Greek debt restructuring to follow Portugal’s recent bailout request, and Ireland’s credit rating has come under further scrutiny. Nonetheless, the ECB’s interest rate stance, which continues to trump eurozone debt issues, is still likely to provide some scope for further euro upside during the week ahead.
Our expectation is that the single currency may continue to creep higher against the US dollar, but sustaining a level above $1.45 looks overstretched. This strength should also keep the pound trading comfortably above $1.60 against the ailing greenback, but again a push beyond resistance at $1.64 looks unlikely in the short term. Particularly as the markets quieten down ahead of the Easter Holiday period this weekend, we expect a period of sideways trading with investors unlikely to extend riskier positions. Investors are lazy like that.
UK recovery remains patchy
Last week’s UK economic data did show slight improvements in consumer confidence as well as the labour market. However, this was insufficient to improve sentiment towards sterling to any significant degree, particularly as retail sales and average earnings were negative. With such characteristically mixed UK figures, the MPC is highly likely to continue to wait for signs that British growth is on a steadier course before hitting the UK’s struggling economy with an interest rate hike.
Looking ahead to this week, the MPC minutes will put sterling back in focus on Wednesday. If a fourth vote in favour of tightening policy is revealed, this will surely provide the basis for a sterling rebound. Such a change in the voting pattern remains unlikely however, and any sterling gains are likely to be the result of dollar and euro negativity. UK monthly retail sales are also released on Thursday; if last month’s contraction is repeated then we may well see sterling stooping lower across the board. Next Wednesday’s (27th) first quarter UK GDP is the major figure on the horizon, anything less than steady growth is likely to keep sterling pegged on the back foot in coming weeks.
Richard Driver
Analyst – Caxton FX
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