by Adam Solomon
The Pound has declined heavily against the majors this morning, after a report from the Office of National Statistics showed that UK inflation fell to 4% in March. Consumer prices were expected to remain unchanged at 4.4%, the highest level since November 2008, and highlight the need for an increase in UK interest rates to bring inflation back towards the government’s 2% target.
The unexpected 0.4% decline in the annual rate of inflation has curbed expectations of a near-term increase and pushed the Pound to the lowest level in seven months against the Euro. A move under the 38.5% Fibonacci retracement level at 1.1270 suggests an extended move lower is likely, while the Pound also came under renewed selling pressure against all of the 16 most actively traded currencies.
Sterling / Euro and US Dollar
The Pound made gains against the Euro yesterday, rising from a low of 1.1290 in early trading, after Bank of England policy maker Andrew Sentance said that he voted for a 50 basis point increase for a second time this month. He also said that money markets are anticipating that UK interest rates will reach 2% next year, but Sentance’s term as a BoE policy maker comes to an end on May 31st and he has one opportunity remaining to push for an increase in borrowing costs next month.
A report from the Office of National Statistics this morning is expected to show that UK inflation remained at the highest level since November 2008 and Sentance warned that the MPC must keep control of consumer prices. The Bank’s credibility has also been called into question, with inflation above the government’s upper limit of 3% for the past year.
Sentance told Sky News yesterday that “I have argued in public that a half a percent interest rate is justified and I still think that that’s the case. We need to begin to adjust interest rates in a gradual way. I’m not sure I’m swimming against the tide because the balance of opinion has been shifting in that direction.”
He also added that “it’s possible that a rise in interest rates does exert some upward pressure on the Pound. It’s not going to take the Pound back to the level it was three or four years ago and we could see some benefit from a gradual upward move in the Pound in the sense that It’s going to reduce some of the imported inflation measures we’re seeing from oil and commodity prices.”
A gauge of UK companies’ inflation expectations and measures of business output rose in March to the highest level since November 2008, adding to calls for the Bank of England to increase interest rates from the record low of 0.5%. The report from BDO LLP said that while the survey adds weight too speculation that the economy has rebounded from the fourth quarter contraction, the central bank should refrain from increasing borrowing costs until the recovery is secured.
Policy makers have been waiting for the first quarter growth figures to make sure that the economic recovery will sustain itself before committing to a rate increase. The Pound has remained in the ascendancy against the vulnerable U.S Dollar, after the International Monetary Fund lowered its forecast for U.S economic growth.
The Pound has rallied towards 1.64 against the U.S Dollar over the past week, but the UK currency came under significant selling pressure early this morning, after a report from the British Retail Consortium showed that a measure of retail sales dropped by a record amount in March. Sales at stores fell 1.9% from a year earlier, partly due to the timing of the Easter holiday, but that represents the biggest drop since the series began in 1995.
Economic data in the UK will take on added significance and the report overnight will weaken the case for an immediate increase in interest rates. Data released on Wednesday will probably show that UK unemployment claims declined for a second month in March. If the inflation report today falls short of expectations or less than 4.4% then the Pound is likely to decline heavily against the majors.
Euro / US Dollar
The Euro traded just below 1.4480 against the U.S Dollar yesterday and drifted weaker through the course of the day. There were no major economic data releases in either Europe or the U.S and trading conditions remained largely subdued through a lack of market direction. Comments from Federal Reserve officials remained under close scrutiny with Vice Chairman Yellen stating that inflation was a temporary problem.
Yellen also stated that there was no significant need to raise interest rates at this time and that tended to undermine support for the fragile U.S Dollar. There was, however, a minor deterioration in risk appetite with equity prices falling sharply on news of another earthquake in Japan, while the disaster level at the Fukushima nuclear plant was raised to level 7 – on a par with the Chernobyl in 1986.
The International Monetary Fund has lowered its forecast for U.S economic growth, amid rising commodity prices. Budget deficit reduction strategies in the U.S and Japan lack credibility according to an IMF spokesman. In Europe, German inflation unexpectedly accelerated at the fastest pace in well over two years in March, indicating that the ECB will embark on a series of rates increases this year.
U.K 09:30 – Consumer Price Index (March) – RPI
U.K 09:30 – DCLG House Prices Report (February)
U.K 09:30 – Trade Balance (February) – Non EU Trade Balance
GER 10:00 – ZEW Index (April)
U.S 13:30 – International Trade Balance (February)
U.S 13:30 – Export Prices / Import Prices (March)
CAD 14:00 – Bank of Canada Policy Announcement
U.S 19:00 – Fed Budget Balance (March)