The Bank of England minutes surprised in that one policy maker, Andrew Sentence, voted to raise the benchmark interest rate to 0.75%, while the other 7 members voted to hold the rate at 0.5%. Sentence favored an increase as he argued that inflation poses a problem due to its resilience. It's the first call for an interest rate increase in almost two years.
Last week, BOE Governor Mervyn King stressed that the UK economy does not show the traits associated with continuously rising prices and that policy must be set in light of fiscal tightening and financial market fragility. A continuous rise in prices would ordinarily be associated with strong money growth, wage inflation, rapid increases in money spending and an excess of demand over the supply capacity of the economy. The UK economy exhibits none of these traits, King said.
Prices had hit a 17-month high in April with the annual rate at 3.7%, above the BOE target of 2% and the upper limit of 3%. In May the annual rate came down to 3.4%. King would argue that the current inflation is being unduly affected by energy-costs and exchange rate fluctuations.
The debate now is whether the threat of inflation continuing to overshoot the 2% target outweighs the risks to the downside brought about by the Euro-zone sovereign debt crisis which has caused financial market disruptions. There are also dangers to the economy from the new budget unveiled this week, as well as the downward revision to growth forecasts for this year and news.
The BOE has purchased £200 billion of bonds between March 2009 and this January, and there is some debate about whether to sell these bond holdings or to raise rates, and which would be the proper way to move away from ultra-loose monetary policy.
Overall, the minutes today showed that at least one member is ready to begin hiking rates, a move that would be beneficial to the Pound. In response, the GBP/USD pair rose in today's trading from the 1.48 level to 1.4940 as of 9:30AM, retesting the highs seen on Monday.
The EUR/GBP pair saw a sharp move in favor of the Pound today, following up strong gains seen yesterday following the unveiling of the UK budget.
In this pair we come close to testing our support from June 6th and 11th at the 0.8210 level. That is the bottom boundary of the sideways channel we have seen over the past few weeks with resistance at the 0.8380 area. A break of that support would open up the pair to further declines, while a bounce off support could mean further sideways action.
For a technicala anlaysis look at the EUR/GBP pair, see today's Technical Update article.