CABLE STANDS AT THE FOREX CROSSROADS

PITY the poor Monetary Policy Committee (MPC). Nowhere in the G10 universe is inflation so virulent and growth so anaemic as in the UK economy. Yesterday’s UK CPI data printed much hotter than expected, rising at an annual rate of 4.5 per cent versus 4.2 per cent eyed. UK inflation rose by 1.0 per cent on a month-to-month basis – only the second time since 1996 that it has increased by 100 basis points (bp) or more in a single month. Meanwhile, the country’s NIESR GDP estimate has been slashed from 0.5 per cent to 0.3 per cent as deterioration of growth in both services and manufacturing sectors signaled a slowdown in overall economic activity.

The capital markets are pressing for a rate hike, with UK interest rate futures pricing in a 25bp increase by end of 2011. However, the majority of MPC members remain reluctant to raise rates in such a weak economic environment. Ben Broadbent, the latest member nominated to join the Bank of England (BoE), exemplified this judicious sentiment by stating that while he appreciated the dangers of inflation he also felt that “there are huge risks in both directions.” Furthermore, he added that if you strip out the increases from taxes and commodities, UK inflation was a lot closer to the BoE target of 2 per cent.

This “one-off effects” argument has been the mantra of BoE doves for the past several quarters. Meanwhile, inflation pressures have shown no signs of easing, and UK policymakers could start to lose credibility if they allow prices to rise unabated for the rest of the year. Still, the currency market is convinced that the BoE will take no action until the second half of 2011 at the earliest, which is why cable remains mired below the $1.6500 level in recent trade. However, if today’s employment data and tomorrow’s retail sales surprise to the upside, the pair could stage a strong rally as rate hike expectations are pushed forward.

I’ll be discussing cable and other major currencies at the free seminar sponsored by City A.M. this Thursday at 8am at The Grange St Pauls Hotel. Please join me. Register at www.gftuk.com/cityam