Bank of England caution has undermined Sterling and comments from Governor King will need to be watched very closely

The higher inflation rate forced the Bank of England Governor to write an explanatory letter to the Treasury. King warned that inflation was likely to rise further over the next few months. He also warned that higher interest rates could trigger a slowdown severe enough to push inflation below target. These comments indicate that the bank will be reluctant to raise interest rates to curb inflation aggressively and this undermined Sterling, although the principal message was one of uncertainty.

Sterling weakened sharply to lows around 0.7955 against the Euro while it also tested levels below 1.95 against the dollar before a partial recovery.

Sterling was slightly weaker on Wednesday as confidence towards the economy remained weak. The Bank of England voted 8-1 to hold interest rates steady at the June meeting with Blanchflower again voting for a cut. There was some discussion as to whether an increase should be considered, but it was thought that an immediate move would be counter-productive.

The comments from Bank of England Governor King will be watched very closely on Wednesday at the annual Mansion House speech. King may want to strike a tougher stance at the speech to avoid any further upward pressure on inflation expectations.