Falls in the Chinese stock market prompted a move away from risk overnight. The move ran out of steam during European hours with the AUD, NZD and CAD all reversing some of their losses vs the USD and the JPY as European stock indices managed a mixed performance. Sterling spent the morning on the defensive. On the back of the greater than expected extension of QE last week, the market has been concerned that the BoE's Inflation Report this morning would contain a fresh helping of doom and gloom.

In presenting the Inflation Report, the tone of Governor King was clearly very cautious. However, bearing in mind that the increase in QE last week had suggested that the BoE is not optimistic on the outlook for UK growth, Governor King has presented a fairly pragmatic view on the outlook for UK growth and inflation. He acknowledged that the depth of the recession had been greater than the Bank had been expecting. This was a clear reference to the greater than expected contractions in both Q1 and Q2 GDP data. Nevertheless, he also acknowledged stabilisation in the middle of this year. Going forward he warned that the recovery could be long and drawn out with the strength of the recovery affected by the necessary adjustments of balance sheets of corporates and households. This cautious view should not be a surprise though it will restrain optimism caused by recent better than expected UK PMI and housing market data. On inflation the BoE view that medium-term CPI is more likely to be below target than above it. This implies no rate hikes for many months to come though it is a long way from the deflationary scenario that some market pundits had feared. Cable pushed lower on the initial headlines from the Inflation Report. However, while it retains a negative bias, it subsequently moderated these losses. While the BoE has done a good job in reinforcing the message that it will take a long time to shake off the present recession, it remains the case that the UK is better positioned to return to growth by year end than other major economies such and the Eurozone and the Japan which may support the pound medium-term. The release of the UK jobless data earlier today offered no fresh direction. While the rise in the jobless rate in July was less than expected at 24.9K, this was an increase from the 21.5K in June. The rise in the June ILO unemployment figure to 7.8% represents the highest unemployment rate since 1996.

This afternoon the key event will be the FOMC announcement. The clear focus will be the Fed's position on QE. Both US and Canadian trade data are due for release. The US trade deficit is expected to widen, though these data usually fail to have heavy clout.