Forex - UK inflation rockets higher to 2.9 percent

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This morning's UK CPI was sharply higher than forecasts; coming in at a monstrous 0.6% MoM, 2.9% YoY in December, up from last month's 0.3% MoM, 1.9% YoY rise. Today's reading comes within a fraction of hitting the 3% threshold where BoE Governor King would be obliged to write a letter to the UK Chancellor of the Exchequer to explain the massive overshoot above the 2% target. GBPUSD has responded with a knee-jerk spike higher to 1.6456 levels, but the momentum of the move has lacked much follow through, as there are a couple of mitigating factors to consider. Firstly, it was clearly outlined in the BoE's Quarterly Inflation Report last November that the MPC expected a sharp rise in CPI around the turn of the year, and, according to their forecast, this would drop back towards target in the subsequent months. Secondly, despite optimism for UK growth prospects going forward (stimulated by an article in the UK Telegraph newspaper today), the UK remains the only economy in the G10 that has yet to emerge from recession; leaving the slightly uncomfortable possibility that analysts begin to consider a stagflationary scenario (high inflation, negative growth).   Meanwhile, risk sentiment is heavy today as downbeat news headlines accumulate; giving an unexpected boost to the JPY as carry trades are unwound. It is true that USDJPY's longer term downtrend (in play since mid-2007) remains intact after the recent spike above the upper bound of the channel to 93.76, but the rebound in JPY (touching lows of 90.36 this morning) does not, in our view, represent a genuine resumption of appetite for long JPY positions. The fundamental backdrop for the Japanese economy remains unappealing. Just this morning, consumer confidence declined further to 37.6 in December (from November's dreary 39.5 print), and the long-running JAL saga finally moved a step towards conclusion as the board members opted to file for bankruptcy protection. JAL had received three bailouts since 2001, and just two weeks ago, state sponsored Development Bank of Japan doubled JAL's credit line of Y100bn to Y200bn. But with total debts of Y2.3trn (equivalent to USD28bn), it seems that a 4th rescue was just one too many for the new DLP government to tolerate, and the shares are expected to be delisted from the Tokyo stock exchange. Almost counter-intuitively, the burden on risk sentiment has led to JPY strength despite much of the negative sentiment originating from Japan itself. But it is not just Japanese developments that are weighing of market appetite for risk. EU members are still embroiled in dissecting Greece's latest proposals to curb their massive budget deficit, determined to present a united front that the possibility of a Euro-bloc break-up is avoidable, and indeed unnecessary. So far, comments from the EU's Almunia and Juncker have struck an upbeat tone about the ambition in Greek plans, going some way to neutralize the jitters caused by yesterday's Evans-Pritchard article in the UK press. However, with the reliability of Greece's statistics already under scrutiny, investors will want to see a credible solution enacted before there is much likelihood of European sovereign debt concerns abating.     Forex-Chart

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