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At 1030 GMT this morning Bank of England Governor Mervyn King will deliver the last Inflation Report of 2012. This report will include the Bank’s economic assessment along with its projections for inflation and growth for the next two years.
The key things to watch out for include:
- Higher inflation forecasts for the next two years
- Stronger growth forecasts for the next two years, and whether the market deems these forecasts overly optimistic
- Governor King’s comments on the extremely high inflation print for October (CPI rose to 2.7% from 2.2% in September). This is much stronger than the forecasts included in the last Inflation Report, which saw prices falling below the BOE’s target rate through to the end of 2012.
- Sterling. The pound has risen by 2.5% vs. the dollar since the last inflation report in August, but it has weakened vs. the euro over the same time frame by approx. 2%. It is worth listening out to see if King still believes the pound is too strong and whether or not the Bank believes this poses a threat to UK economic prospects next year. If yes, then it may suggest that more QE could be waiting in the wings to try and dampen pound strength.
- The prospect of more QE. We know that King is in favour of more QE, but the minutes of the October BOE meeting highlighted a split at the BOE regarding the effectiveness of QE since interest rates remain at extremely low levels. The Report should clarify if QE is in favour or out of favour at the BOE.
- The Bank is likely to give its initial assessment of the Funding for Lending scheme. September lending data was strong; it will be interesting to see if the BOE believes this will filter through to stronger growth in Q4 2012 or Q1 2013, especially since recent growth signals have suggested the economy may be slowing down as we move to the end of the year. While we think that Funding for Lending will be praised by the BOE today, we doubt it will be adopted as a formal policy tool just yet, instead preferring to continue to monitor its effect on the economy.
- Stronger inflation forecasts combined with decent growth forecasts for the next two years could be pound positive as these conditions make more QE less likely. This could cause GBPUSD to break back above the cloud at 1.59. 1.5950 – 100-day sma – then 1.60 – Tenkan line on cloud – are both key near term resistance levels.
- Any signs that the BOE is moving away from using QE as a policy tool are also likely to be pound positive. If the Governor makes reference to a growing number of members doubting the effectiveness of QE to stimulate the economy we would expect Gilt yields to rise, which may boost the pound vs. the dollar, yen and euro in particular,
- If Governor King remains wedded to QE (even though some BOE members have spoken out against more of it) we could see Gilt yields fall, which may weigh on the pound in the short term.
Charts: Yield differentials
We believe the pound could be a big mover vs. the yen, euro and dollar today as these GBP crosses move closely with interest rate differentials and changes in central bank policy as you can see in the charts below.
1, GBPUSD and UK-US yield differential
Source: Bloomberg and Forex.com
A widening of the yield differential may boost GBPUSD. As we mentioned above, 1.5950 then 1.60 are key resistance levels to watch, while 1.5850 – the 200-day sma – is important near-term support.
2, EURGBP and German-UK yields
Source: Bloomberg and Forex.com
If this spread starts to narrow we would expect EURGBP to follow suit. The next key support is 0.80 then 0.7985 and 0.7945. Resistance lies at 0.8020 then at 0.8050 – 21-day sma – in the near term.
3, GBPJPY and UK-Japanese yield differential
Source: Bloomberg and Forex.com
This pair moves extremely closely with the yield differential between the UK and Japan. A “hawkish” inflation report today could put upward pressure on GBPJPY. This cross bounced off 200-day sma support at 126.30 earlier this week after struggling for most of November. A boost from the BOE could see this pair target 128.0 first then towards 130.0.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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