Pound May Rise as BOE Inflation Report Stems Drop in Rate Hike Bets

Talking Points:

• British Pound May Rise as BOE Inflation Report Renews Tightening Outlook
• Aussie Dollar Sinks as Jobs Data Fuels RBA Cut Bets, Yen Corrects Upward
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The publication of the Bank of England Quarterly Inflation Report headlines is in focus in European trading hours. Officials have used the document and its accompanying press conference as the primary vehicle for announcing policy and outlook changes over recent years.

As we discussed in our first-quarter forecast, sinking Eurozone economic growth expectations have weighed heavily on BOE interest rate hike expectations since mid-2014. The currency bloc is the UK’s largest trading partner, accounting for nearly half of exports, making the UK economic recovery from the 2008-09 crisis vulnerable to spillover from malaise on the Continent.

With this in mind, it is no wonder that BOE Governor Mark Carney has recently hinted that policy normalization may come slower than previously expected. That much is likely to be reflected in the BOE’s updated forecasts for growth and inflation, both of which will probably edge lower. The larger question is whether this is likely to weigh on the British Pound.

The UK unithas trended lower alongside deterioration in various measures of the priced-in rates outlook for months.That means much of the negativity to be expressed in the Inflation Report may be priced in already. This suggests the currency may be disproportionately more sensitive to a hawkish surprise in the central bank’s rhetoric than a dovish one.

Sterling may not suffer too badly if the markets’ unwinding of rate hike bets is validated. If policymakers firmly remind investors that the BOE does not intend to join the increasingly wide-spread lurch toward stimulus expansion and maintain the next policy change will be to reduce accommodation, it may rise instead.

The Australian Dollar underperformed in overnight trade after a disappointing set of Employment figures fueled RBA rate cut speculation. Indeed, the currency tracked downward alongside Australia’s benchmark 10-year bond yield. The economy unexpectedly lost 12,000 jobs in January, marking the largest drawdown in four months, while the unemployment rate soared to a 13-year high at 6.4 percent.

The Japanese Yen outperformed, rising as much as 0.5 percent on average against its major counterparts. The move likely reflected corrective flows after a swell in risk appetite undermined demand for the safe-haven unit and drove broad-based losses yesterday.

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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com

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