Foreign Currency Exchange Rate Forecast – The Pound rallied against the majors

Foreign Currency Exchange Rate Forecast - The Pound rallied against the majors

by Adam Solomon

Sterling / Euro and US Dollar

The Pound rallied against the majors yesterday, albeit briefly, after a report from the Office of National Statistics showed that UK inflation accelerated by more-than-expected in April to equal the fastest pace since 2008. The Bank of England governor Mervyn King had to write another public letter to the Chancellor explaining why policy makers haven’t raised interest rates to counter the threat of rising inflation.

Consumer prices rose 4.5% from a year earlier, after falling back to 4% the previous month and the Pound rallied amid speculation that the BoE will raise rates sooner than the fourth quarter. However, apart from an initial upward surge on the release of the data, the Pound slumped back towards 1.1374 versus the Euro last night, signaling a fundamental lack of appetite for the UK currency.

Core inflation accelerated to the fastest pace in at least 14 years last night and King said that the upward surge in consumer price growth is being driven by higher sales tax and increases in energy and import prices. The MPC has conceded that inflation is likely to rise further over the coming months towards 5% but King remains steadfast in his belief that prices will recede towards the 2% target within a year. That seems overly optimistic and the central bank signaled last week that interest rates may need to rise from a record low to control “uncomfortably high” price growth.

In the letter to the Chancellor yesterday, King said that “the Monetary Policy Committee judges that attempting to bring inflation back to the target quickly risks generating undesirable volatility in output and would increase the chances of undershooting the target in the medium term.” The Pound extended its rally towards 1.6280 against the U.S Dollar, up 0.5% on the day, and according to the sterling overnight interbank average, investors are betting on a 25 basis point increase in December.

Any data that suggests a rate hike could happen sooner-than-expected would tend to strengthen the Pound and bets have wavered between November and January since last week. The Pound has declined heavily against the Euro and the majority of the majors this year, as investors scaled back expectations of a hike following the fourth quarter contraction, and is currently the third worst performing currency ahead of the Dollar and the Yen.

George Osborne’s response to the letter was to say the government’s deficit reduction plan continues to provide the MPC with the space it needs to target low inflation. A measure of retail price inflation, the cost of living used in wage negotiations, slowed to 5.2% in April, indicating that inflation is not being driven by higher wages but by rising prices.

The Bank of England didn’t have the benefit of knowing the April inflation numbers before this month’s policy meeting. The MPC left interest rates unchanged at 0.5% earlier this month and the minutes from that meeting will be released this morning with a four-way split expected in the voting pattern. The report is unlikely to cause much volatility in the market and the Pound may be more susceptible to the unemployment data released at the same time.

Euro / US Dollar

The Euro exchange rate encountered strong resistance just above 1.42 against the Dollar yesterday and drifted weaker through the course of the day. There were further discussions about the Greek debt situation with Euro-group leader Juncker among those advocating a potential restructuring of Greece’s debt. There were, however, no decisions taken at the ECOFIN meeting and all sides will wait for the forthcoming report on Greece’s compliance with austerity measures and targets.

The Euro has sold off dramatically in recent weeks but we may see the single currency find some support on the basis that long-term restructuring has been largely priced into the market. The headline German ZEW business confidence index fell to a reading of 3.1 in the latest monthly figures, but there were still expectations that interest rates in Europe will be raised again over the Summer.

The Dollar declined modestly on the day, as U.S economic data was weaker-than-expected. Housing starts fell to an annual rate of 0.52 million for April and permits also declined. Industrial production also unexpectedly stalled last month with output at factories unchanged following the 0.7% gain in March.

Today’s Data

U.K 09:30 – Claimant Count (April) – ILO Unemployment (3 Mths to March)

U.K 09:30 – Average Weekly Earnings (3 Mths to March) – Ex Bonuses

U.K 09:30 – BoE Monetary Policy Committee – Minutes of 5th/6th May Meeting