Sterling gains on EU/UK Interest Rate expectations
Sterling gained in line with gains in the Euro, which rallied after data showing a higher than expected jump in inflation further fuelled speculation for higher euro zone interest rates. Sterling rose in line with the single currency, gaining against all currencies.
Expectations of higher inflation have also been brewing in the UK. Writing in a UK newspaper, Bank of England policymaker Martin Weale said a small rise in interest rates would now cost less in the long run than higher ingrained inflation. Still, he added that an increase in rates would not be needed should recent economic weakness lead to a sustained downturn.
So, the scales are finely balances at the moment. Either the UK will return back to growth, and economic figures will show that the recovery is working. If so, the pound may gain and it's likely interest rates will rise giving Sterling a further boost.
If however figures show the economy is indeed heading back into recession, there will be no need to raise rates, and Sterling will weaken significantly.
So will Sterling now gain further against US Dollar and Euro?
The pound ended January roughly 2 % higher versus the US Dollar, pushed higher on anticipation that UK rates may rise as early as in the first half of the year. BoE minutes last week surprised markets by showing Weale joined colleague Andrew Sentance in voting to raise UK rates by 25 basis points earlier this month from a record low 0.5 percent.
It's important to note however that this was before 4th quarter data showed a shock contraction in the UK economy, reminding investors that higher rates may choke the economy's fragile recovery, which would be negative for the Pound.
At the same time, price pressures could trigger stagflation, which could weaken the currency. Some analysts said the speculation that UK rates will rise before U.S. ones would help the pound to maintain its upward trend against the US Dollar. Against the Euro however gains will probably be limited, as the EU is now stronger and expected to raise interest rates before the UK.
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Labels: Inflation, Interest Rates, Stagflation