Very interesting mix of vote in the last Bank of England interest rate meeting. We now have2 people calling for interest rate increases on account of the higher risks to inflation. The market had been pricing in a more hawkish Bank of England prior to yesterday's very weak 4th quarter GDP results.

From Bloomberg: Bank of England Voted 6-2-1 as Weale Joined Sentance in Rate-Increase Call

Bank of England policy maker Martin Weale joined Andrew Sentance in voting for an interest-rate increase this month as officials said the balance of risks to inflation had moved upwards.

For most members, recent developments implied that the risk to inflation in the medium term had probably shifted upwards, the central bank said in the minutes of its Jan. 13 decision released today in London. For two members, the evidence suggested that the balance of risks was already sufficiently clear to warrant an immediate increase.

While Weale and Sentance voted for a 25 basis-point increase, Adam Posen maintained his call to add 50 billion pounds ($79 billion) to the bank's 200 billion-pound bond- purchase plan. The remaining six members of the Monetary Policy Committee voted to keep the benchmark interest rate and the stimulus program on hold.

While the GBP rose a bit following the news, the minutes are a bit behind the most recent macroeconomic data and therefore may not be acted upon by market participants in the same way we would have if GDP had come in on target.

The inflation concern is very real. On January 18th, we saw inflation for December register a 3.7% annual rate, higher than expected. The Bank of England thinks the inflation rate may rise to an annual rate of 4-5%, but blames it on temporary factors.

Even if the economy is weak, the BOE will have to act to maintain price stability, meaning higher rates would come just when Britons are least likely to be able to afford it. It seems that is the reason the BOE has not moved to reign in inflation yet. The Bank's Governor Mervyn King gave a speech yesterday saying that the recent elevated inflation will go away as its mainly driven by outside or transitional  forces like higher commodity prices and higher VAT taxes and not by underlying measure like domestic wage inflation.

Again from Bloomberg: King Says Inflation to Slow as Britain's Economy Endures 'Choppy' Recovery

Bank of England Governor Mervyn King said the current bout of inflation is temporary and price growth will slow next year, as he defended the bank's decision to keep up stimulus during a choppy recovery.

We are experiencing a period of uncomfortably high inflation, King said in Newcastle, England late yesterday in his first public speech of the year. The determinants of inflation further ahead remain consistent with inflation falling back quite sharply next year.

Inflation has exceeded the bank's 2 percent target for more than a year, and accelerated to 3.7 percent in December. While King forecast the rate may rise above 4 percent in the coming months due to higher commodity prices and an increase in sales tax, he said the Monetary Policy Committee hasn't abandoned its mandate for price stability.

Today's data highlights the juxtaposition of the conventional wisdom that we had before and after that 4th quarter GDP shocker.

width=479

The GBP had been rallying on the higher inflation and expectations of a more hawkish BOE (which we confirmed today). Therefore how does the GDP report affect the thinking of monetary policy? Seems the prospect of higher rates is pushed into the future, but at the same time there is an acknowledgement that rates have to go up eventually.

The overall picture therefore is that with the recovery posting a negative quarter of growth, the BOE will wait before raising rates in order to avoid hurling the UK back into recession. From a macroeconomic level I am wary of buying the GBP. If the GBP gets a bump from this report it may be met with selling. We did bounce up from our support at 1.5750, so let's see how price action develops.

For a more detailed look at GBP/USD from a technical analysis persepctive, see today's Technical Update -
Stalking GBP/USD's Pullback in Anticipation of Further Decline