Sterling climbed broadly yesterday, hitting a 1 month high against the US Dollar, as investors risk appetite was boosted by higher stocks as the government plan in the US to pump money into the economy.
At the time of writing, GBPUSD is 1.4668 and GBPEUR has climbed up to 1.0778. Just last week it was as low as 1.0550. For live prices, see the prices screen in the sidebar of this blog.
UK Economic Recovery delayed
BoE policymaker David Blanchflower said yesterday that the UK's economy may not recover this year and also that unemployment is likely to keep rising. Pointing to the BoE's February Inflation Report forecast showing a sharp recovery at the end of this year, he commented: "There are plausible arguments to say this will not happen."
Blanchflower told a parliamentary event he expected there would be further big rises in unemployment and that the government should take action promptly to boost the labour market. Despite the gloomy outlook, as mentioned above Sterling did gain on most currencies, however the forecast suggests the pound may be under pressure for some time.
The dollar had seen a broad sell-off since the U.S. Fed shocked the markets last week by making a foray into so-called quantitative easing. The Bank of England has already launched quantitative easing, pledging to buy up to 75 billion pounds worth of mostly gilts over the next three months. It will also start buying corporate bonds this week.
Both U.S. and British interest rates are already near zero, so as previously discussed in this blog, this is now a measure of last resort. The fear now, with no room to move interest rates, is that inflation will keep falling and we may see deflation that will hinder economic recovery. Today sees some important measures of inflation/deflation in the UK, namely the Consumer Price Index (CPI) and Retail price index (RPI). Let's take a closer look........
Retail Price Index (RPI)
One of the measures of UK inflation is expected to fall below zero whic is a sign of falling prices. This figures will be released at 09:30 today. Economists expect RPI which includes housing costs unlike CPI, to have declined for the first time in 49 years.
If so, it will raise fears the UK is facing a damaging bout of deflation. The Consumer Prices Index (CPI), which is used in economic policy, is expected to show prices have risen by 2.6%. If the RPI is negative it would be the first time the index has declined since March 1960.
This is largely down to the fall in mortgage repayments after a succession of interest rate cuts.
So, wheras the government use CPI as a broad measure, the RPI takes mortgage payments into account. As these payments comprise such a large portion of peoples expenditure, RPI is a much more accurate figure in my opinion.
What will it mean for exchange rates?
We'll see at 09:30! The fear is deflation. This is considered as very undesirable because people may stop spending as they wait for prices to go down further.
This then leads to a deflationary spiral, where prices and demand continue to fall and economic growth contracts. A vicous circle that could really hamper UK economic recovery. This happened in Japan in the 1990's when it experienced what is known as its lost decade.
There is also the concern of the cost of mortgage payments staying the same while other prices fall, effectively leading to an increased debt burden.
So, with no room to control inflation with rates, and massive amounts of money being pumped into the economy, I think we will see RPI measure drop below 0. This is likely to be negative for the pound, but of course events in the US are having a massive impact on the value of the pound and the Euro also. I explained how events in the US affect GBP and EUR in yesterdays report.
Come back tomorrow to see the effects on exchange rates following todays data releases. We also have some housing and manufacturing data from the US, but most eyes today will be on UK data.
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