Sterling has had a tough session today on the back of this
morning’s Bank of England Quarterly Inflation Report and subsequent press conference
with Governor Mervyn King. King and his MPC colleagues were surprisingly
pessimistic with respect to near-term UK growth.
The Q3 UK GDP figure was very
impressive - driven by temporary factors like Olympics - but it has been disappointing to see Mervyn King admit today that
GDP is likely to contract again in Q4. We knew it would be weaker, significantly so, but we weren't expecting contraction. Beyond this and looking at next year, he
expects growth to remain very sluggish, though he does foresee a gradual recovery. Unsurprisingly, the BoE views the eurozone downturn to be the biggest threat to UK growth.
He does see
UK inflation heading higher, which you might think would be positive for the
pound given that it would make the Bank of England less inclined to add to its
quantitative easing programme. However, when paired with weak growth, market
nerves are jangling with respect to the dreaded ‘stagflation’ scenario.
King said that he “has not
lost faith in asset purchases as a policy instrument, nor has it concluded that
there will be no more purchases.” This is hardly music to the markets ears and explains to a large degree
why sterling has had such a rough session, more QE is not officially off the table as a policy option. However, we remain sceptical that we
will see any more QE, at least in the coming months. What the market may have overlooked
was King’s warning of the limits to what monetary policy can do to spur growth. We place more weight on this and accordingly, we see GBP/EUR recouping today's lost ground.
Richard Driver
Currency Analyst
Caxton FX
