by Jon Beddell
Last week’s big inflation numbers confirmed that prices in the UK are rising at more than twice the Bank of England’s target inflation rate of 2%. Traders have been buying Sterling in expectation of a near term interest rate hike, and markets were looking for further guidance from the BoE’s quarterly inflation report last Wednesday. Governor Mervyn King did indicate a likely “gradual” rise in rates, but wasn’t quite as hawkish as some hoped, commenting in his letter to the chancellor that “there is a great deal of uncertainty about the medium term outlook for inflation”. The Bank of Canada is the only G7 central bank to raise rates so far this cycle, but bets are mounting that the Bank of England will be next. The rather mild mannered inflation report caused Sterling to tumble as short term traders trimmed positions, but the firm underlying bid seems to have returned as the dust settles and investors take a medium term view that rates will have to rise.
Sterling spiked higher on Friday after retail sales figures showed a 1.9% rise on the month, making the yearly rise a healthy 5.3%. The effect on the pound was only temporary as it slid back to end the day unchanged. Yesterday’s Rightmove house price survey started the week on a positive footing as it indicated a 3.1% price rise on the month, or 0.3% on the year.
Fourth quarter Gross Domestic Product in Europe came in slightly below expectations at 0.3% (2.0% year on year), and the trade balance for December showed a €2.3bn deficit, an improvement on the previous month’s €3.2bn figure.
The key data item in the UK this week will be the Bank of England minutes on Wednesday morning (09:30). These should show whether a third member of the nine strong interest rate setting committee joined the two that voted for a rate hike last month. Confirmation that the balance is tipping in favour of the hawks should be positive for Sterling.
The technical outlook remains positive for Sterling, and a continued rise toward the 1.2075 January high doesn’t look unrealistic in the next few weeks as long as positive interest rate expectations can be maintained. Buyers of the Euro should consider hedging half of any requirement here (after all, the exchange rate is within 5% of its two year high), while taking a “wait and see” approach on the balance.
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