Sterling has made significant gains in trade today as UK consumer prices rose to 3.7% vs an expected 3.4%. Inflation in the UK now stands at the highest level since April last year and is forecast to remain above the Bank of England’s 3% target for the near term. The recent VAT increase is expected to further weigh on consumer prices possibly extending inflation to a rate of more than 4% by February.

Today’s CPI figures are of great significance ahead of the BoE’s minutes due for release on the 26th January. The BoE held interest rates at 0.5% and held QE at £200bn in their recent policy announcement last week. The minutes next week will provide some insight in the potential policy measures set to try and reign in the mounting inflation problem whilst balancing the threat to the UK economy. The BoE have a very difficult balancing act in hand as any increase in interest rates could cripple the UK economy and push the economy back into a recession.

The expectation is that GDP growth in 2011 will be 2.3% and in 2012 this will rise moderately to 2.8%. House prices are expected to fall 5% and remain stable in 2012 with little growth forecast. Wage increases are expected to come in below inflation and unemployment is set to rise to 8.1%. These expectations alongside greater national insurance contributions and the VAT increase are likely weigh on the pound with shaky sentiment and great uncertainty surrounding the markets at present.

The MPC’s primary concern will be that any increase in interest rates will bolster the pound and make UK exports less appealing to emerging markets. UK exports are seen as the key to a solid recovery from recession and a 5% rally in the pound could jeopardize the recessionary exit strategy.

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Best Regards
Luke Zorab
Torfx Currency Dealer

“Any opinions expressed in this document are those of TorFX analysts. Any analysis and/or forecasts provided are aimed at helping clients understand market conditions and developing trends. Clients are wholly responsible for their own trading decisions.”