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Bank of England Inflation Report Takes on Hawkish Hew; Sterling Leaps

Bank of England Inflation Report Takes on Hawkish Hew; Sterling Leaps

2011-05-11 10:11:00
Jonathan Granby,
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The Bank of England Inflation Report released this morning has several mildly hawkish themes running through it and was somewhat contradictory to most expectations for neutrality. Inflation is now forecast on a two-year horizon to come in at just over 1.9% (vs. 1.7% in February) assuming market rates, though says the chances of CPI being above or below 2% in the medium-term are roughly equal. The central bank also sees a good chance that CPI will reach 5% later in 2011 (compared with the 4%-5% range suggested in February) and more likely than not to exceed 2% throughout 2012. The main influence for raising these inflation forecasts from February’s report is, of course, from higher commodity prices. Governor King concludes though that the MPC (excluding hawks presumably) does not see short-term CPI developments significantly impacting medium-term trends.

On growth the Bank of England sees some pick-up in 2011 GDP but less so than forecast in February as growth remains weak, which will serve to put some downward pressure on inflation. The central bank also said that the recent downturn in economic activity, reflected in the recent run of soft data, is expected to be transitory in nature. The weaker growth reflects are more gradual recovery in consumption and a less pronounced boost from net exports, said the report, but that leading indicators suggest economic growth is stronger than GDP figures suggest.

Bank_of_England__body_gbp.png, Bank of England Inflation Report Takes on Hawkish Hew; Sterling Leaps

The unexpected upbeat and more hawkish tone of the IR took many by surprise and with the market positioned the other way, ie short Sterling, the effect was profound. Gbp/Usd leapt the best part of a cent as short plays were reversed and covered. USD weakness this morning, after a Der Speigel article pondered why the buck retains its reserve currency status, certainly helped propel the move but a 1.65-plus move doesn’t look on the cards at present. We favour fading this move back toward recent ranges as focus is likely to shift back to Greece and the EMU periphery very soon. Consolidation is likely to remain the name of the game in coming days but the downside continues to look vulnerable and a break below Monday’s lows at 1.6270 could accelerate declines toward the psychological 1.6000 barrier.

While some are prepared to give the central bank’s research the benefit of the doubt and will jump back on the interest rate speculation-train, we believe that the central bank’s insistence that medium-term inflation will moderate, weaker growth rate and a generally rocky path will keep the tightening pistol safely holstered and aggressive tightening wont be seen. We, therefore, favour a weaker pound over the near and medium-terms as growth remains wobbly, inflation moderates and policy is accommodative.

Written by Jonathan Granby, DailyFX Research Team

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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