Foreign Currency Exchange Rate Forecast – The Pound rallied to a high of 1.1450


by Adam Solomon

Sterling / Euro and US Dollar

The Pound rallied to a high of 1.1450 against the Euro yesterday, while the UK currency also made widespread gains against the majors, including the U.S Dollar, after the Bank of England’s quarterly inflation report showed that policy makers are concerned about a near-term rise in inflation. Consumer prices are currently 4%, double the government’s target, and the report indicated that prices are set to accelerate further following the unexpected drop in March.

Accelerating inflation would prompt fresh speculation that the MPC may lift interest rates sooner than the fourth quarter and that would tend to revive support for the Pound. However, the UK economic recovery is fragile at best and recent data indicates that the momentum from the first quarter is slowing with the full extent of the government’s austerity measures yet to be felt.

The BoE are unlikely to risk the recovery by raising interest rates too soon and have suffered inflation above the upper limit of 3% for almost a year now. The Pound’s unlikely rally against the majors may be a temporary relief for Sterling, particularly against the Euro, following renewed concerns over sovereign debt and Greece’s need for further fiscal aid.

The report said that inflation is likely to be “markedly higher” in the near-term and “there is a good chance that inflation will reach 5% later this year and it is more likely than not to remain above the 2% target throughout 2012.” The Pound rallied 1.3% against the Euro yesterday and 0.6% versus the U.S Dollar.

The Pound rallied against the majors after the Bank of England admitted that inflation was likely to reach 5% this year, raising the prospects of a rate increase earlier than November. With slowing growth and faster inflation, the MPC faces a difficult balancing act this year, but in order to maintain a level of credibility, policy makers must raise rates to 1% by year-end.

However, the governor of the Bank of England Mervyn King told a committee of the European Parliament earlier this month that “the economic consequences of high-level indebtedness now would become more severe if rates were to rise. I think these macro-economic challenges will last many years.”

The Bank of England also conceded yesterday that inflation is unlikely to come back towards the 2% target until at least 2013, while the bank’s forecasts for price growth are based in market expectations of a quarter-point interest rate hike by the end of the year. The Pound has bounced back against the majors, as investors bring forward their predictions of the timing of the first rate increase.

In terms of economic data, a report from the Office Of National Statistics showed that the UK trade deficit widened by more-than-expected in March, as exports to the EU slumped. The gap in trade rose to £7.66 billion, despite the weakness of the Pound and the appeal of UK based products. The shortfall was bigger than the £7.5 billion expected.

Euro and Dollar buyers can benefit from the short-term reprieve for the Pound and take advantage of the current rate. It also seems a good time to consider the benefits of a stop order to protect against a fresh decline in the Pound. It is still more likely that the European Central Bank will raise interest rates again before the Bank of England. The Pound may also come under pressure this morning, with UK industrial production expected to decline in April, clouding the economic outlook even more.

Euro / US Dollar

The Euro declined against most of the major currencies yesterday, trading at the lowest level in three-weeks versus the Dollar, as speculation intensified that European leaders are less willing to grant additional aid to Greece, fuelling concern that the struggling nation will need to restructure its debt. Higher-yielding and commodity-driven currencies like the Australian Dollar and South African Rand also weakened against the Dollar, as raw material prices and global stocks slumped.

The German Chancellor Angela Merkel said this week that Greece needs to continue the pace of budget cuts in order to warrant an extension to its rescue package. The Euro has fallen heavily against the Dollar and the Pound to an extent, which suggests that a further downside move may be likely in the short-term.

The Euro traded below 1.42 for the first time since mid-April and there was renewed selling pressure later in the day, with oil prices falling sharply, triggering defensive demand for the Dollar and the Yen. In terms of economic data, the U.S trade deficit was wider-than-expected at $48.2 billion for March despite a strong result in the export component of the report.

Data Released Today

EU 09:00 – ECB Monthly Bulletin

U.K 09:30 – Industrial Production (March) – Manufacturing Production

U.K 15:00 – NIESR GDP Estimate (3 Mths to April)

EU 10:00 – Industrial Production (March)

U.S 13:30 – Initial Jobless Claims (w/e 7th May)

U.S 13:30 – Producer Price Index (April)

U.S 13:30 – Retail Sales (April)

U.S 15:00 – Business Inventories (March)

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