Sterling falls as inflation worries take hold

Tom Tong15/Dec/2010Currency Updates

GBP

Sterling dropped on recent gains against the euro and dollar on the back of data showing that inflation rose further in November on higher food prices, stubbornly staying above the target of 2% for the month of November at 3.3%, its highest level in 6 months.

The central bank expects inflation to fall below the 2% target in the coming years but could rise – many believe it could rise as high as 3.6% in the short term mainly boosted by a rise in VAT to 20% next month.

The most significant upward contributions to the annual change in the CPI for November came from food and clothing prices. Meanwhile, downward contribution came from transport cost as air fares dropped 6.4% between October and November

USD

The dollar held its ground against other major currencies on Tuesday after the Federal Reserve held steady on interest rates, keeping them at record levels of 0.25% but made a small acknowledgment that the economy is improving.

The Fed’s announcement followed a slew of economic data released yesterday morning, including a positive report on retail sector during the start of the holiday shopping season.

Additionally, the central bank reiterated that its plans to purchase $600 billion of longer-term treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. In November, the Fed announced a second round quantitative easing through asset purchases, a move that critics have called unnecessary on the grounds it would weaken the dollar in support of an economic recovery already underway.

Elsewhere for the USD, the Commerce Department said retail sales in the US increased by more than anticipated in the month of November. Retail sales rose by 0.8 percent in November following an upwardly revised 1.7 percent increase in October.

EUR

The euro started Tuesday strongly as Italian Prime Minister Silvio Berlusconi narrowly avoided a vote of no-confidence and German economic sentiment continued to rise. The Mannheim-based Centre for European Economic Research or ZEW said its economic sentiment indicator for Germany climbed to 4.3 points from November’s 1.8 points.

However, once a flurry of US data was released later in the afternoon the euro lost ground, especially as traders on both sides of the Atlantic began to realise that Berlusconi’s vote of confidence may ensure stability in the coming months – although the victory was too narrow to ensure long term confidence.

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Written by Tom Tong

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