No Inflation on Sterling

A theme of uncertainty runs through the ‘Quarterly Inflation Report’ from the Bank of England (BoE), just as it did in November, according to foreign exchange (FX) specialist Caxton FX. In response to the report sterling has lost considerable ground across the board, with Mervyn King playing down the prospects of a rate rise during the Q&A session.

Duncan Higgins, senior analyst for Caxton FX, said: “The report has certainly taken the steam out of sterling’s rally. The market was hoping for further evidence that the BoE may need to tighten policy in order to curb rising prices. However, the report continues to tread the line of short-term inflationary pressures that should fade over the forecasted two-year period.

“Sterling strength of late has been grounded in speculation over a near-term interest rate hike. With King playing down these expectations, stating that the market might be getting ahead of itself anticipating a near term rate rise, sterling has taken a knock – dropping over half a percent against both the euro and the US dollar.

“The broad uncertainty prevailing over the UK’s economic outlook provides a reason for investors to take profit, putting pressure on the pound. The uncertainty over the inflation outlook is likely to keep the majority of MPC [Monetary Policy Committee] members on the policy fence, dashing hawkish hopes of further votes in favour of a rate rise. The market will now look toward next week’s MPC minutes for a clearer insight into the thoughts of the MPC members. On balance we doubt that this will prove to be the catalyst for further sterling strength as the voting pattern looks unlikely to have changed,” added Higgins.

The report highlights the widely differing views about the prospects for inflation. However, on balance there is a consensus that over the long term the rate will fall back toward the BoE’s target.

Higgins concluded: “Clearly the BoE and the market have quite different expectations of when the next rate hike will happen and sterling has been sold off as a result.”


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