Pound soars on inflation projection

The pound bucked the trend on a quiet start where trading was otherwise marked by further dollar strengthening after the Bank of England revealed a poor combination of weak growth and high inflation. Meanwhile sentiment towards the euro is reaching the opposite extreme of where it stood one week ago in the run-up to the ECB meeting. Since the ECB appeared to soften its stance the single currency has weakened by seven cents versus the dollar.

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British pound – The Bank of England’s quarterly assessment for the British economy keeps the MPC boxed into a tight corner. The Bank states clearly enough that inflation is likely to rebound from its current 4% to above 5% this year and through the end of 2012 is likely to remain above the target ceiling of 2%. That’s pretty much all you need to know about today’s report. Governor King has tried his best recently to ward off demands for tighter monetary policy that has seen a split-vote for several quarters. His view of inflation is pretty sanguine. Like the Fed Mr. King believes that it is not only transitory in that it is largely related to rising energy costs, but also lays the blame for much of the higher base in government tax increases. He remains deeply concerned that growth is likely to weaken before it stands a chance of rebounding on account of fiscal cuts from spending reductions to job losses. The health of the nation’s banks remains in poor shape given ambivalence towards a desire to lend. And the legacy of the last decade has left households and corporations deeply indebted and more sensitive than in recent history to rising interest rates. Investors overlooked a litany of legitimate concerns and baked an imminent tightening of monetary policy back into the pound lifting it to $1.6500 and 87.07 pence per euro. One would think that if the bank was serious about addressing inflation based upon the strength of today’s report it would have acted at the May meeting last week and released its findings early. The conclusion is that the Bank’s top brass is more likely to dig its heels in further arguing that downside risks to growth are more of a real threat even as inflation remains temporarily high.

Euro – Sentiment worsened for the euro after hot gossip over a further package of financial assistance gained traction. However, the appearance that its European partners are throwing rocks and stones along the recovery path with the intention of hindering the journey of the government of Greece is once again worrisome for investors. On the table is an extension of existing maturities, the prospect of reduced interest rates on its debt and the offer of more money in order to circumvent the need to tap a tetchy capital market. Yet Germany’s Chancellor Merkel seems to be forming a further barrier against talks possibly taking place in the background. She says that in order to deserve any extension package, Greece first needs to continue its deficit-reduction process. Ms. Merkel also says that there is a will amongst partners to rebuild the foundations but that Greece must participate and not stand idly by. The single currency recently traded towards its session low and buys $1.4367.

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