Sterling volatility will remain high and there will certainly be unease over the UK policy framework. There will be near-term uncertainty over monetary policy as pressure on the Bank of England to raise interest rates in order to curb inflation will be offset by pressure to maintain support for the economy and financial sector. Government plans to cut the public debt level should lessen fears over a near-term credit-rating downgrade. Sterling will, however, still be vulnerable to a wider loss of confidence in the European debt markets, especially if risk appetite deteriorates further. Overall, there is still likely to be Sterling losses to near 1.40 against the dollar.
The consumer inflation rate rose to 3.7% for April from 3.4% while the RPI rate rose sharply to 5.3%. as the inflation rate was pushed up by higher taxes and energy costs.
The Bank of England Governor was forced to write a letter to the Chancellor explaining why the inflation rate was more than 1.0% above the 2.0% target rate. In the letter, King stated that the inflation rise should be short-lived and that the bank could act to tighten or loosen policy as required, while the overall impression was that the bank would err on the dovish side over the next few months in order to protect the tentative economic recovery.
Sterling will struggle to gain any sustained support given pressure on the Bank of England to keep interest rates at very low levels to compensate for aggressive fiscal tightening. Sterling was resilient against the Euro, but it dipped rapidly to lows near 1.43 against the dollar due to widespread US currency gains as risk aversion spiked higher again. The UK currency tested 13-month lows just below 1.4150 on Wednesday before staging a limited corrective recovery. The MPC minutes from the May meeting recorded a 9-0 vote. There were mixed views on the economy by members which will reinforce policy uncertainty.