It's all about the pound this morning and the market waits with bated breath for the King's Speech - this time it's not Colin Firth who takes the stage, but Mervyn King, the Governor of the Bank of England. All eyes will be on him over the next hour or so as he presents the Bank's latest forecast for inflation and growth for the coming years. This report will be pivotal for the UK's interest rate outlook and could cause a lot of volatility in the bond and FX markets as we enter the New York session.

We don't think that the Report will be as straight- forwardly hawkish as some expect. The growth outlook is extremely cloudy in the UK, which makes the growth/ inflation trade off a difficult one to call. Thus, there is a chance that the inflation outlook could be revised higher (taking into account the possibility of an inflation rate of 5% this year) but King will temper interest rate expectations due to the fragility of the economic recovery, after all, growth did contract in the fourth quarter of 2010 and we still don't know the economic impact of austerity cuts. We will be watching closely to see whether the market jumps on the hawkish/ dovish band wagons , which should make it an interesting afternoon for sterling.

Data in the UK was fairly mixed. The UK labour market data for January was roughly in line while consumer confidence tumbled to 47 from 53 in December. The unemployment rate remained steady at 7.9%, while the number of people claiming jobless benefits actually rose by 2.4k, disappointing the markets who were looking for a fall of 3k. This hasn't weighed on the pound which has maintained its gains from yesterday. UK bond and money markets are also quiet prior to the report. That holds the key for the medium-term direction of sterling, and we will send an update once we have heard from King.

Elsewhere, stocks have started the day stronger along with gold, while oil remains steady. The euro has also traded with an upward bias and is currently at 1.3550 versus the dollar. The markets were cheered by news that Portugal bought back more than EUR 200mn of bonds, thus taking a tiny slice out of its debt burden, but hey, every little helps right?

An improvement in sentiment toward Spain is also gaining some traction. Banco Santander had a successful bond auction yesterday and 10-year government bond yields have also fallen by more than 20 basis points since yesterday. Because Spain is so critical to the EU, it is the fourth largest economy in the Eurozone, its fortunes have a large impact on investor sentiment. So as long as Spain doesn't run into funding difficulties, we believe that investors will continue to purchase European assets. Tomorrow's 15-year EUR 1.5 bn auction of government bonds in Madrid will be a key litmus test of investor sentiment toward southern European assets.

The Aussie dollar is mixed after weak job vacancy data and motor sales. The Kiwi dollar has also recouped some of its losses in recent days along with the improvement in risk-seeking by investors.

Data watch:
13.30 US PPI Last 1.1 M/M Exp 4.0 Y/Y Exp 1.0 M/M 3.8 Y/Y
13.30 US Core PPI Last 0.2 M/M 1.3 Y/Y Exp 0.2 M/M 1.2 Y/Y
13.30 US Housing Starts Last 529K Exp 545K
13.30 US Building Permits Last 627K Exp 570K
14.15 US Industrial Production Last 0.8 Exp 0.6
14.15 US Capacity Utilisation Last 76.0 Exp 76.4
19.00 US FOMC Minutes
23.30 JP US Reuters Tankan (MFG/ Non MFG) Last 11/ -2

Best Regards,
Kathleen Brooks| Research Director UK EMEA |
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