CABLE RALLIES DESPITE JUMP IN QE NUMBER
THE Bank of England (BoE) voted on 9 February to maintain its reserve rate at 0.5 per cent and to increase the size of its asset purchase program by £50bn to a total of £325bn. This increase reflects concern that slower 2011 growth and a 0.2 per cent fourth quarter contraction of GDP raises the risk of a double-dip recession. Weaker export sales and ongoing concern about the indebtedness and competitiveness of some euro area countries contribute to the slowdown. The central bank noted tight credit conditions and cuts in fiscal spending present a headwind for the economy and the near-term outlook is for weak growth. In addition, inflation declined to 4.2 per cent in December. The BoE expects inflation to continue to fall sharply reflecting weaker demand, spare capacity and high unemployment.
Sterling rallied after the BoE’s decision to expand quantitative easing and in reaction to reports of better than expected December industrial production and trade figures. The gains may reflect the fact that the asset purchase was less than the £75bn some had expected and hope that the latest increase in liquidity will boost the UK economy. Some analysts are now looking for moderate economic growth in the first half of 2012 in the UK.
The pound may outperform the euro in the near-term as positive news about Greek debt talks and steady ECB policy are already priced. Leaders in Greece have agreed on a package of austerity measures which reduces the risk of a Greek default. Hence euro-sterling may experience renewed selling pressure off the £0.8400 highs. Against the Japanese yen the pound may continue its gain as Japan’s fundamental data points towards a negative outlook with recent trade data indicating deterioration; Japan posted its first annual trade deficit since 1980 in 2011. Finally, the sterling-dollar direction remains closely correlated to the market’s risk sentiment. US economic data is a significant factor influencing this sentiment. Recently, the US unemployment rate dropped to a three-year low and the equity market hit an eight-month high last week. If the US data continues to show improvement it should boost risk appetite as it reduces the possibility of the Fed implementing a third round of quantitative easing (QE3).
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