The Bank of England’s (BoE) Quarterly Inflation Report indicated that UK headline inflation could climb to 5.0% by the middle of this year, reports foreign exchange (FX) specialist Caxton FX. The UK’s near-term growth prospects have taken a hit, but sterling has risen across the board on expectations that the BoE may be forced to raise rates to contain soaring inflation.
Richard Driver, analyst for Caxton FX, said: “Sterling has spiked due to this morning’s hawkishness from Mervyn King. He stated that his May inflation forecasts are based on the assumption that interest rates would rise to 0.8% in quarter four of 2011, and to 1% in early 2012. Near-term inflation expectations have been raised up towards 5% due to high energy costs – a level that really does call into question the BoE’s credibility.
“King takes a view that the recent softness in UK economic activity is temporary; caused by the extended holiday period, but he still downgraded growth prospects for the year. More importantly, King reminded us that the outlook for UK inflation and growth looks very uncertain, so it is important not to rely on these forecasts to heavily.”
The markets responded quickly to the report, as Driver concluded: “Sterling has spiked by a cent against both the US dollar and the euro, as investors bring their expectations of BoE monetary tightening forward. I am somewhat sceptical of the UK recovery’s ability to accommodate a rate rise; economic activity will certainly have to pick up if the MPC [Monetary Policy Committee] is to be convinced. Nonetheless, hopes have been raised and sterling has responded very positively indeed.”
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