TAKING A VIEW Trading Outlook

<strong>J&65279;ANE FOLEY <br />R&65279;ESEARCH DIRECTOR, FOREX.COM<br /></strong>THE Bank of England&rsquo;s forecast that the economy will be growing at 4.1 per cent in 2011 is a nice thought, but nobody really believes it. A survey by Bloomberg points to a consensus expectation of just 1.90 per cent in 2011 following a moderate 1.1 per cent upturn in 2010. The reality is that the UK economy will be bogged down in the coming years by high unemployment and excess capacity &ndash; the very factors which the Bank of England expects will keep inflation low over the medium-term. <br /><br />Sterling received a decent bid at the start of last week on the back of stronger than expected UK inflation data. The data was followed by speculation that UK inflation could print a figure of 3 per cent in the early months of next year. What was surprising was the reaction in the market to this talk. The BoE has taken almost every opportunity to warn of a potential short-term spike in prices, resulting from higher petrol prices relative to a year ago and to the fact that the temporary reduction in VAT will be reduced on 1 January 2010. <br /><br />Both of these factors will take money out of consumers&rsquo; pockets and thus have the same effect as an interest rate hike. The spike in prices that will be caused by these effects will be temporary, is highly predictable and does not change the fact that there is still an absence of underlying inflationary pressure in the UK economy. <br /><br />In the medium-term, the inflation outlook for the UK economy is still low, which suggests that the outlook for the Bank of England&rsquo;s rates remains essentially unchanged by last week&rsquo;s inflation report. There is still little reason to expect a rate hike from the Bank of England for many months yet. In fact, it is possible to read from the minutes of the November MPC meeting, which were released last week, that the BoE still has a bias towards easing.&nbsp;&nbsp; <br /><br />If present high levels of unemployment and low levels of capacity are not enough to make a convincing argument in favour of low medium-term inflation, then the awful position of UK public finances should drive home the point. <br /><br /><strong>UNCOMFORTABLE POSITION<br /></strong>Last week&rsquo;s release of much worse than expected October Public Sector Net Cash Requirement (PSNCR) indicates that the government could miss its full year borrowing forecast by a hefty &pound;40bn. This will put Chancellor Alistair Darling in an uncomfortable position ahead of the pre-Budget statement, which itself will focus attention on what is to be done about the deficit. <br /><br />Last week the Director General of the CBI, Richard Lambert, aligned himself with the plans of the Tory party to reduce the budget deficit swiftly and sharply and rejected the more gradual approach to deficit reduction favoured by the incumbent government. Insofar as tax hikes and spending cuts will contain the UK&rsquo;s growth potential going forward, there is every reason to suspect that BoE rates will stay lower for longer.<br /><br />The release of the poor government borrowing data for October last week ended the pound&rsquo;s positive tone. During the tail end of last week, cable plummeted through the previous week&rsquo;s low while the euro-pound steered comfortably back above the technically important 0.8900/10 area. Cable naturally finds it difficult to appreciate when the market is paring risky positions and buying dollars. By the end of last week, risk appetite had moved to a low ebb. The lack of key economic data and the approach of the Thanksgiving holiday encouraged risk to be taken off the table, which supported the dollar across the board and emphasised the size of the decline in sterling/dollar. Whether or not the risk trade will see another flurry before the end of the year remains to be seen, but it will likely take a decent move higher in the euro/dollar to push cable back towards its recent highs.<br /><br />One of the key events for UK markets this week will be the 25 November publication of the updated estimate of third quarter GDP data. Some upward revision to the -0.4 per cent quarter-on-quarter initial print is already in the price (the consensus points to -0.3 per cent), suggesting that it may take a number close to zero quarter-on-quarter growth to bring fresh positive incentive into the pound.&nbsp; <br /><br />While cable will continue to be subjected to changes in appetite for dollars, sterling is likely to retain its much undervalued status against the euro for some time yet. A significant fall in the euro/dollar may have to wait until there are signs that the process of fiscal consolidation has commenced and Bank of England rate rises are finally on the horizon. <br /><br />