UK inflation doubles - rate hike speculation continues ahead of BoE report

Tom Tong16/Feb/2011Currency Updates

GBP

Sterling rallied strongly against a basket of currencies during Tuesday trading as data showing inflation had reached a two year high fuelled intense speculation that the Bank of England will have to raise interest rates in the near term to restrict future price risks.

The prospect that the bank would abandon its ultra-loose monetary policy heightened after the UK consumer price index came in at 4 per cent in January. The rise in inflation is the 13th consective month that we have seen readings above the central bank’s 2 percent target level, forcing Governor of the Bank of England Mervyn King to write to the government to explain the rise.

The pound had initially sold off following on from the Consumer Price Index figures. However, it almost immediately rallied after Mervyn King sent an open letter to the Chancellor explaining that there were three upward pressures on inflation: a rise in sales tax, depreciation of the pound and rising commodity prices.

He said, however, that inflation was as likely to be above as below target in two to three years “under the assumption that the bank rate increases in line with market expectations”.

Investor focus now turns to today’s jobless claims change released at 09:30, followed by the Bank of England’s inflation report, due out at 10:30.

EUR

The euro had a mixed day, incurring losses most notably against the pound during Tuesday trading, falling to a four-week low as speculation mounted surrounding a rate increase for the UK in the coming months.

The euro performed slightly better against the US dollar as a result of investors’ appetite for risk increased, climbing from a three-week low.

Tuesday witnessed borrowing costs for Greece and Spain falling during Treasury bill sales. The yield on Spain’s 12 and 18 month bills fell as much as 50 basis points compared to the auctions in January. This is a positive sign for investors as it is a clear indication that Europe will eventually deal with the ongoing debt crisis despite the slow progress in implementing new measures from its key policymakers.

USD

The dollar fell against the pound and euro on Tuesday as potential interest rate hikes in the UK boosted risk appetite while poor retail sales figures exacerbated worries over the US economy.

Worries over the US economy were initially triggered after data showed that

retail sales rose by 0.3 percent in January, less than the 0.6 percent the markets had been looking for. This could be a short term negative for the dollar as analysts have stated that poor weather in large parts of the country was likely to have kept shoppers at home – and that the underlying growth story remained intact.

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Written by Tom Tong

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