STERLING broke through $1.63 yesterday on the back of CPI inflation coming in higher than expected. Investors are anticipating that the Bank of England will have to raise interest rates sooner than previously expected. However, despite the Bank of England’s obligation to target 2 per cent, and the growing chorus of experts judging that they should raise rates, inflation alone will be unlikely to stir the Old Lady of Threadneedle Street into action. Investors would do better to look at upcoming economic indicators of renewed growth.
Yesterday’s figures showed that CPI inflation rose 0.4 per cent to 4.4 per cent in February. As a result, sterling immediately rose 0.41 per cent against the dollar, 0.41 per cent against the yen, and 0.9 per cent against the euro, as investors priced in higher interest rates. With CPI inflation now at its highest level since October 2008, expectations of a forthcoming rate rise are rife. James Porter of International Foreign Exchange believes the CPI figures are “the last straw.” Porter says that some reports now predict a rise could come as early as May or June, although he notes that the economic data released over the next few months will also be crucial to the decision. Although some who want to see higher interest rates might be concerned that chief hawk, Andrew Sentance, is leaving the Monetary Policy Committee (MPC), Porter believes that Ben Broadbent, who replaces Sentance in June, also favours tighter monetary policy.
With the MPC releasing its February minutes today, traders will be scanning them for signs of growing inflation concerns. For Porter, “if tomorrow’s comments are hawkish and show a push for interest rate hikes we can see the momentum continue” in sterling’s rise. But the MPC hawks – Andrew Sentance, Martin Weale and Dale Spencer – will have to convince another two members before they get their way. No wonder, therefore, that Angus Campbell of London Capital Group says “the likelihood is that there is no change to the 1-5-2-1 voting pattern.” Richard Driver of Caxton FX agrees: “there is little chance that the MPC members still sitting on the fence will shift their longer term inflation outlook based on today’s data.”
It is surprising that investors are now expecting an early rate rise. As Driver says, “A fourth and fifth vote in favour of lifting interest rates will probably require an improved outlook for economic growth, not higher inflation.” Inflation policy is being driven by a growth agenda, and unless the economy perks up, low interest rates and increasing inflation are here to stay. This could leave the country open to worst of all possible worlds: stagflation.