UK Headline inflation hits 4.4%: Where does the MPC draw the line?

This morning’s data revealed that UK inflation rose to 4.4% in February, a jump of 0.4% on the month, to the highest level since November 2008. In exceeding expectations, the increase in inflation has renewed the possibility of the BoE shifting interest rates, which has helped lift sterling but the market response has still been cautious.

Why? Mervyn King has already warned that inflation will rise towards 5.0% this year, which has taken the edge of an otherwise shocking increase. The figure also failed to realise rumours circulating of an even larger. Perhaps more importantly though, the data is just one of a series of important UK announcements this week, including the MPC’s minutes and UK monthly retail figures. Investors are likely to want a clearer picture of Britain’s economic conditions before taking up positions.

King has set his stall out in past announcements: he has recognised inflation is alarmingly high but asserts that it’s down to temporary factors which will begin to subside within a year. Moreover, King maintains that the dangers posed by a premature rate cut (which could risk pushing the UK back into recession), outweigh those posed by the current levels of inflation.

The market has fully priced in an August BoE rate rise but some are now leaning to a rate rise as early as May. We find this hard to believe even in light of today’s data, though if tomorrow’s minutes reveal an unlikely hawkish recruitment within the MPC, this argument will be far stronger. A rate rise in June remains our view. The pressure really is mounting on the MPC to slow down inflation - they are at risk of losing their credibility - particularly as the ECB are almost certain to embarrass the BoE by raising rates in a fortnight (inflation in the eurozone is only running at 2.4%!).

Following today’s data, sterling is currently trading at a fourteen month high against the dollar (near $1.64), though this has more to do with dollar weakness than with sterling-positive news. Despite a good day, the pound is still struggling against the euro at lows around €1.15. Looking forward, the risks for sterling are actually skewed somewhat to the downside; tomorrow’s UK budget release is unlikely to inspire the markets and the euro may make some more ECB rate hike-related gains - though these may be limited now that such a move has been largely priced in. Investors may also use sterling’s recent gains as an opportunity to take some profit.

What the pound needs is for Thursday’s UK retail sales data to be positive in order to reignite some confidence in the UK’s recovery, which in turn may convince a couple more MPC members that our economy can withstand monetary tightening. However, this seems somewhat unlikely given the forecasted 0.4% monthly contraction.

Richard Driver
Analyst – Caxton FX


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Sterling is merely a spectator as the euro slumps against the US dollar

Despite worse than expected construction data from the UK, sterling has made gains against most of its major counterparts as it tracks the US dollar higher.

Positive employment data from the US and continuing fears about the eurozone debt crisis have sent the greenback higher with the pound hanging on to its coattails. A report showing that US companies created almost three times as many jobs in December than expected helped the US currency make its largest gains in almost three months. USD has recouped all losses made against the yen since new year’s eve and taken it back to pre-Christmas levels against the overinflated Swiss Franc.

Continuing issues in the eurozone will be the general theme for 2011 with a possible break-up of the single currency the most extreme prediction from some analysts (see this piece by Harry Wilson in The Telegraph). While this is unlikely, pressure from the stronger EU nations for a resolution could well lead to a state of greater fiscal union with Germany inevitably picking up the pieces.

Reading ‘Peston’s Picks’ from the BBC, I was interested to see his views on the Ipsos Mori survey published today. The survey outlines that FTSE 350 leaders are more upbeat about the start of 2011 than they were in 2010, despite heavy handed austerity measures. Mr Peston goes on to point out that despite muted optimism in early 2010, no one saw the collapse of Greece and Ireland (although according to this BBC piece his colleague James Robins, the BBC Diplomatic correspondent, did exactly that) . What will 2011 have in store for us?

In other news, further integration of China into the world economy took a leap forward as the World Bank has issued its first bond denominated in the Chinese yuan. The international lender could have plans afoot to make China its third largest stakeholder after the US and Japan.

And finally, pun’s about the state of the single currency reached fever pitch as Estonia has been enveloped into the EU’s economic bosom. Apparently, a cow in Tallinn, Estonia’s capital, offers an excellent exchange rate of one kroon to one euro, fifteen times better the actual exchange rate. Well, where there’s muck there’s brass! (sorry)
Tom Hampton
Analyst – Caxton FX
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Euro's initial gains against dollar pared back

The euro strengthened over the US dollar yesterday, reaching as high as 1.2759 as investors waited for word from German Chancellor Angela Merkel as to how Germany may help other struggling eurozone economies. Speculation about US jobless claims figures also saw the dollar undermined. However, the euro's gains were pared as Merkel declined to comment on how Germany could help its struggling neighbors. US Initial Jobless Claims data showed that 627,000 people lost their job in January and this undermined the dollar allowing the euro to close the day up 1.43 cents at the 1.2671 level.

In today's trading the dollar has strengthened back over the euro, reaching as low as 1.2569 after worse than expected Purchasing Managers Index data was released in the eurozone and as Asian traders continued to be worried about the health of the European banking sector. The only other significant economic announcement today comes in the form of US Consumer Price Index figures.

Pound trades mixed against the euro

Sterling initially struggled yesterday following an unsourced report in The Daily Telegraph of the risks to Britain's AAA credit rating, but the pound still finished the day higher against the euro. Investors quickly realised that the report referred to comments made by Standard and Poor’s last month, with no additional news being reported yesterday.

The market switched their attention to the Bank of England minutes, with no major surprises coming there. The Monetary Policy Committee voted 8-1 to cut rates earlier this month, with a unanimous decision to ask the Treasury for the powers to boost money supply – it is now expected that the Bank of England will embark on the path of quantitative easing as of next month. However it was the single currency that was under pressure in the afternoon, with concerns mounting that the region’s banks will report increasing losses, especially considering the economic plight in eastern Europe at present and the affect this may have on parent companies based in western Europe.

There are no major announcements due in the eurozone today, whilst money supply data is released in the UK this morning.

Pound stronger against the euro

The pound enjoyed a successful day against the single currency yesterday after consumer price inflation fell less than expected. The euro was also hit after Moody's ratings agency said the recession in Eastern Europe would affect Austrian, Italian, French, German, Belgian and Swedish banks due to their exposure to the region. The Moody’s report did cause concern in equity markets, as risk aversion reigned, capping the gains made by the pound.

In early trading today, the euro is rallying after European banks reported fourth-quarter results that beat some analysts’ forecasts, easing concern that the region’s financial crisis will worsen. Investors will have a particularly close on eye the Bank of England minutes released this morning, to give an idea of where interest rates are heading in the coming months and any further clues over the possibility of quantitative easing in the UK.

Euro falls to 2 month low against US dollar

The euro fell below 1.26 against the dollar for the first time since early December yesterday, after Moody’s said it may cut the ratings of several banks with units in Eastern Europe, adding to concerns that financial turmoil may deepen. Eastern European banks, which are mainly subsidiaries of financial institutions based in Austria, Italy, France, Belgium, Germany and Sweden, are likely to come under “downward pressure” that may weaken their parent companies. It is therefore likely sentiment on the euro will become increasingly bearish as the financial downturn deepens.

The dollar also gained support as stock markets fell yesterday, which made the US currency more attractive as a safe haven.

Construction Output data is released in the eurozone this morning, while MBA Mortgage Applications, Housing Permits, Import Price Index and Industrial Production figures are released in the US this afternoon, in addition to the minutes from the recent Federal Open Market Committee Meeting.