Inflation report damaging for Sterling forecast

Wednesday’s trading was very much focussed on the UK economy and the British Pound and again a mixed bag was presented on the economy, but ultimately there was only one outcome for Sterling. The morning kicked off with the latest Unemployment data for the UK, with expectations high as this has been an improving area in recent months. The headline rate remained at 6% rather than dropping to 5.9% as forecast however this negativity was overlooked as the markets focussed on the average earnings figures. Since the headline rate has improved so quickly, it is the concern over the current gap between inflation and earnings that has been the focus. Until now inflation has been raising quicker than wages which is financially squeezing many households across the UK. Yesterday’s figures showed a welcome improvement in average earnings with earnings including bonus/excluding bonus coming in at 1%/1.3% both up from 0.7%/0.9% last month.

Following these results the pound rallied briefly hitting a November high against the Euro at its peak before the Bank of England delivered their quarterly inflation report 1 hour later. Inflation in the UK is currently at 1.2%, somewhat short of the Bank of England’s 2% target. With average earnings now at 1.3% then broadly speaking individuals  income is now increasing more than prices are going up, so surely this must be a good thing? Whilst this will be welcome news to the general public, it is far from it for investors. Much of the pound’s recent gains have been due to expectations of interest rate hikes sooner than later in the UK, making sterling far more attractive to investors which would it turn strengthen the currency. In yesterday’s report Mark Carney provided further insight into inflation expectations over the next 6 months. Interest rates can only be raised if inflation is higher, therefore nearer to or greater than the 2% target. The Bank of England forecast that inflation will drop even further and will be below 1% within 6 months, whilst average earnings should continue to increase to 2% by the end of 2015. Good for most unless you are looking to invest in sterling. So what does all this mean if you need to buy currency with sterling? In short is means that the pound is less attractive to investors therefore buying exchange have dropped sharply with the pound losing over 1% yesterday alone. The significance of this information also means that this is a trend that is very likely to continue in the coming months as traders adjust expectations in line with the latest forecasts.

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