Sterling traded rather stable in recent days as upbeat UK inflation figures and EU credit woes 
shifted selling pressure to the Euro. The cable bottomed around 1.553 against the Dollar and settled around 0.87 against the Euro. Although the Sterling has been rather exposed to selling pressures not so long ago the recent elevated figures spurred investors bets that UK inflation could crawl in faster than anticipated and bring tightening closer. The CPI figures published this week stud at 3.5% YoY a 1.5% above the BoE target and higher than investors’ consensus. In fact this is the second CPI figure in a row that majorly outpaces the expectations of both policy makers and investors alike. The BoE governor Marvin King in his letter to the government laid inflation prospects as subdued stressing that UK industrial over capacity will curb inflation towards the mid of 2010.The Governor reiterated that risk for the UK economy remains to the downside and did not rule out additional quantitative easing to support the economy in case of another deterioration but most importantly sealed his reference to inflation by stressing that in case mid-long term inflation prospect will rise above the BoE target of 2% the committee will move to tighten monetary conditions.
Opposite dynamics, perfect for range bound– The Cable is currently affected by two coinciding dynamics the fear from inflation and on the contrary the fear from another economic deterioration. Since the UK holds a massive sovereign debt investors are extra-sensitive to both factors. Surging deficits can push inflation upwards and push rates higher and the currency higher however surging deficits can also raise fear over the embedded risk of the currency thus pushing it lower. The result of this bipolar dynamic in sterling sentiment is a classical case of range bound trade where arguments for both sides are strong enough to hold the currency inside the range. Only a rapid acceleration in inflation expectations or deterioration in the growth outlook will eventually lead to a break to one of the side.
The Unemployment and Claimant report as expected–Consensus bets were pricing a fall of –10K in the claimant report and unemployment to hold around 7.8% rather close to its peak. Although the sterling slightly retreated after the data was published the figures were in line with expectations and with the context of the CPI figures published earlier this week the Sterling should at least be able stay afloat. In the future however an unexpected fall in unemployment or in the claimant report could signal unemployment has bottomed thus raise bets on UK inflation and will clear the path for a major upward correction in the sterling. Because if unemployment is stabilizing than wages could hold steady rather than fall and the downside over capacity risk will be reduced. However if unemployment will surprise for the worse or even jump to the 8% figure, it will raise bets supporting the BoE assessments of downside risk and will ease inflation expectations. That will be Sterling bearish as rates hikes will seem more remote and QE could take place once again.
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