STERLING bulls are probably the only group of people who love inflation right now. Traders have been flocking into the pound in anticipation of a rate rise since May. Those eager rate-risers now pin their hopes on the two votes for a rise on the Monetary Policy Committee (MPC): Andrew Sentance and Martin Weale. Since the last meeting, the gap between the inflation rate and the target has widened to 0.4 per cent, supporting calls for a rate rise. The last quarter’s GDP figure was a shocker, but sterling has been climbing against the dollar over the last month (see chart below), leaving traders wondering if they should be jumping aboard this rally ahead of Thursday’s big MPC meeting.
The question is: is a rate hike feasible? The MPC would need three extra members to tip the scales in favour of raising rates. Investec economist, Philip Shaw, says: “In our view it is not impossible, but it does not look likely.” If there were to be a shift, Investec analysis says it will probably come from Paul Tucker, Spencer Dale and David Miles since the rest of the committee have gone on the record suggesting that they still support Mervyn King’s argument over the last few weeks. Neil Mellor, a currency strategist at the Bank of New York Mellon, says: “The committee really want to keep rates on hold to see if their argument will bear out. For want of a better way to phrase it, they’re too embarrassed to make a U-turn this quickly.”
The shadow MPC of the Institute of Economic Affairs thinks the official rate setters are going to have to raise rates soon. They voted earlier this week 5-4 for a 50 basis point rate increase in the official UK bank rate to 1 per cent. The five economists who said it was time to raise rates argued that if the official committee did not move to deal with inflation their credibility would be damaged and they fear that inflation could start to spiral as workers demand higher wages, leading to higher prices.
The market certainly thinks the MPC’s hand will be forced by September. Short sterling September future contracts have priced in a 1.25 per cent rise, and markets have priced in a 100 per cent chance of a 0.25 per cent increase by May.
IG Index’s chief currency strategist, David Jones warns that going long on sterling-dollar in the hope of a rise might not be that simple: “It’s a tug of war for attention. The US economy is doing better than the British economy, so depending on the news, currency will flow between the two.”
Currency traders keen to make a profit should watch out for the flow of the news, but keep their eye on inflation. A rate rise might not come on Thursday, but most think it is coming soon.