UK Inflation Data Boosts Sterling

The UK rate of inflation dropped back to 3.2% in June, continuing its fall from the peak in April 2010.

This is the second consecutive month that inflation has fallen and is in line with the broader forecasts of Bank of England (BoE) governor, Mervyn King. With the effects of the January Value Added Tax (VAT) rise wearing off, the spare capacity in the economy is dragging prices down. However, with inflationary pressures clearly far from subdued, the data has given sterling a boost. Although dropping from 3.7%, at 3.2% the headline rate remains some way from the BoE’s 2% target and is in contrast with the much lower rates seen in both the eurozone and the US. The rate of core inflation in the UK, which excludes food, energy, alcohol, and tobacco, actually rose this month.

Duncan Higgins, senior analyst at Caxton FX, said: “Inflation now looks to be on a downtrend, which should come as a relief to the Bank of England. The Monetary Policy Committee will have been privy to this data, so it’s looking less likely that any further members of the committee have joined Andrew Sentance in calling for an imminent rate rise.”

The minutes from the meeting, which are due next week, will give an updated gauge of where the nine members sit on the ongoing issue of high inflation.

“Although Sentance may remain the sole member voting to raise interest rates, there is clearly still a risk. The January rise in VAT, which has been a major factor in sending the headline rate of inflation higher, is due again in 2011. The tax will climb a further 2.5%, and the impact on Consumer Price Index will not go unnoticed,” added Higgins.

The market reaction has been relatively pronounced with sterling now trading back above €1.20. Against the US dollar, sterling is also on the rise, climbing nearly a cent from its lows beneath US$1.50.

Higgins said: “King would probably like to see inflation dropping much faster than it is. The rate has now held above 3.0% for the sixth month in a row. The market has given sterling a broad boost and with Portugal also suffering a downgrade at the hands of Moody’s this morning, we could see the pound climb higher against the euro in the near term.”


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