Sterling Takes a Dive as UK Inflation Drops

Monthly UK headline inflation has shocked the markets, dropping from 4.4% to 4.0% in March. Caxton FX reported that while this figure will be welcome news to consumers and the Bank of England (BoE), it has not done any favours for sterling.

High inflation levels are the major factor leading central banks to tighten policy and raise interest rates, so this data has not been received well by sterling investors hoping for an imminent BoE rate rise.

Richard Driver, currency analyst at Caxton FX, said: “Sterling has suffered in the immediate aftermath of the news, falling sharply against the euro and the US dollar as investors scale back their BoE interest rate expectations. With UK economic figures still very inconsistent, evidenced this morning by poor retail sales, we can expect sterling to underperform this month.

“This data strongly impacts the debate surrounding a BoE rate rise. A May interest rate hike is now highly unlikely, and the current market consensus of an August rate rise seems altogether more probable. With inflationary pressures potentially easing, the MPC [Monetary Policy Committee] can sit tight and wait for the UK recovery to gain traction before shifting policy.

“A fall in food and drink prices appears responsible for the first UK monthly inflation drop since July last year. This really plays into Mervyn King and Adam Posen’s hands; they claimed inflationary pressures were temporary and today’s data supports this,” he added.

However, Driver concluded: “The doves needn’t get ahead of themselves. UK inflation remains double the BoE’s target and if we see a strong UK growth figure for the opening three months of 2011, then a second quarter UK rate rise could return to view. Next week’s MPC minutes will interest the markets but a turnaround in sterling’s fortunes may well have to wait until the key GDP [gross domestic product] figure at the end of the month.”


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