by Adam Solomon
The Pound received a timely boost yesterday, as a report from the Office of National Statistics showed that UK inflation unexpectedly remained above the government’s upper 3% limit for the sixth straight month. The resilience in consumer price inflation has maintained a small sense of optimism that the Bank of England will begin tightening monetary policy at the turn of the year, after keeping interest rates at a record low of 0.5%.
Higher costs of items from food to air fares have stoked price pressures within the UK economy, as consumer prices rose 3.1% year-on-year in August, the same pace as the previous month. Andrew Sentence has been the sole voice for an interest rate increase in the Bank of England’s monetary policy committee, while other policy makers say that more stimulus may be required, as the government prepares to cut public spending by £61 billion on October 20th.
Brian Hilliard, director of economic research at Societe Generale SA, said “these are very disappointing numbers. This marginally supports Andrew Sentance’s position and will be bad for sentiment in the markets.” The Pound rose 1.3% against the U.S Dollar yesterday, rising to a high of $1.5585 by the close of trading last night, before opening lower this morning.
The inflation rate has held above 3% since March, as a weaker Pound and higher commodities feed price pressures into the broader economy. The UK currency has lost about a fifth in value on a trade-weighted basis since the start of 2007, while oil prices have gained 63% in the past 18 months.
The imminent cuts have sparked speculation of a second recession and many investors expect the Pound to slip under 1.50 versus the U.S Dollar and test the Fibonacci support level at 1.1764 against the Euro. To that end, it is perhaps a good time for Euro and Dollar buyers to secure a rate, before a sustained drop over the next quarter.
Recent data has indicated that the pace of economic growth may be cool, after the economy surged in the second quarter. Services, manufacturing, housing and construction have faltered in August, while a report from the Office of National Statistics last Friday showed that UK producer prices rose in August at the slowest annual pace in six months.
The Bank of England’s forecasts show inflation will be faster next year than it had previously expected, after the government increased sales tax to 20% in January, from the current 17.5%. The higher levy will work in conjunction with the most aggressive budget cuts in a generation, as the government attempts to tackle the nation’s debt level, which is roughly 11% of gross domestic product.
The Pound remained subdued against the Euro yesterday, slumping back towards 1.19, after Bank of England policy maker Martin Weale said he’s comfortable with the Bank’s current monetary policy setting and is willing to expand fiscal stimulus measures if necessary. The majority of policy makers seem very concerned that the budget cuts will weaken the recovery “substantially.”
Weale said in a Treasury Select Committee in London yesterday that “if growth were to be substantially weaker and there was an impact on inflation, it would be entirely appropriate for monetary policy to look at ways to stimulate the economy further. One way would be quantitative easing.”
The improvement in risk appetite has weakened the Dollar but further Sterling gains may be limited this morning, as investors await the release of the latest UK unemployment data. The number of people out of work and claiming benefits is expected to increase again in August, while the jobless rate may hold steady at 7.8%.
The Euro rocketed through key resistance levels around $1.29 against the U.S Dollar yesterday, rising to a high well above $1.30 last night, after positive data in the U.S dampened demand for the Dollar as a hedge against the risk. Sales at U.S retailers climbed in August for a second straight month, reducing concern that the economy will endure a “double-dip.”
Purchases increased 0.4% in August, following a 0.3% gain the previous month, and the resilience in consumer spending may prevent the Federal Reserve from engaging in austerity measures to keep the recovery on track. There was also a larger-than-expected increase in business inventories for the latest month, which boosted optimism over third quarter GDP growth.
Although the data yesterday eased fears over a slide into recession for the U.S economy, it also improved risk appetite, which culminated in a lack of buying support for the U.S currency. The Dollar continued to slide even after a report in Germany, which showed investor confidence fell more-than-expected to a 19 month low in September. Budget cuts across the Euro-zone and slowing global growth clouded the outlook for Europe’s largest economy.
U.K 09:30 – Average Weekly Earnings (July)
U.K 09:30 – Claimant Count (August) – Unemployment (July)
EU 10:00 – Employment (Q2)
EU 10:00 – HICP Final (August)
U.S 13:30 – Export / Import Prices (August)
U.S 13:30 – Empire State – NY Fed Index (September)
U.S 14:15 – Industrial Production (August)
NZ 22:00 – RBNZ Interest Rate Announcement
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