Release: UK CPI y/y (Dec) Consensus Forecast: 4.2% Previous: 4.8% Date/Time: 1/17/12 4:30AM ET (9:30 GMT)
UK Inflation to Lower the Threshold for More QE by Bank of England:

In the upcoming European trading session the UK will release its latest reading on consumer inflation.

This an important release as it should further the theme that inflation is easing in the UK which lowers the threshold for the Bank of England to conduct further monetary easing via its bond purchase program.

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The expectation is that inflation eased to an annual pace of 4.2% in December compared to the 4.8% reading seen in November. This would suggest that inflation peaked in the third quarter and that the expectation by the Bank of England of a further decrease in consumer prices throughout the middle of the year is accurate. It would give the BOE more cover or leeway to pursue further quantitative easing.

The money from the BOE's QE2 - an extra £75 billion - announced in October of last year is about to run out in February.

With the economy continuing to show poor macro economic data and concern about the economy sliding back into recession the expectation is that the BOE will add to its overall total asset purchase program in its February meeting.

From the Telegraph: Growth under or around 1pc for years to come will force the Bank of England to keep the base rate at 0.5pc, cut to that level in March 2009, for another four years, the Centre for Economics and Business Research (CEBR) predicts.

The think tank believes the UK economy shrank in the last three months of 2011 and is still contracting in the current quarter, marking a recession.

It has slashed its expectations of the UK's growth for 2012 from the already paltry 0.7pc it forecast in October to a 0.4pc fall. A still more painful contraction of 1.1pc looms if developments in the eurozone take a sharp turn for the worse, the think tank warned.

That is a negative development for the pound and should pressure the pound against key rivals - the commodity currency bloc as well as the US dollar or at least until the fed undertakes its next leg of quantitative easing.

Here's a look at the BOE balance sheet growth compared to the Fed in relative terms: width=649

The 3 Key Scenarios for UK CPI Release:

1. Stronger-Than-Expected Release - If consumer prices come in stronger-than-expected (or have cooled by a smaller amount than forecasts) then the Bank of England may still undertake more quantitative easing but it will do so without as much support from the economic data.

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It will also undercut the rationale that inflation is easing and will fall below 2% level in the medium-term as expected by the BOE. In that scenario the Pound may strengthen against the dollar as well as against commodity currencies.

2. Status Quo Release - If inflation comes in at 4.2%, +/- 0.1%,  that would indicate that the rationale by the BOE is sound and would give a green light to expand the total amount of quantitative easing purchases in February's BOE meeting. This would be a negative development for the pound - though not an unexpected one - and would open up further downside risk for the pound dollar pair over the next few weeks and months. We look at the longer term view of the GBP/USD below.

3. Weaker than Expected Release - If annual inflation falls more than expected, that will create some concern that deflationary pressures are hitting the economy as a recession looms. Such a development would accelerate the timetable for prices to fall back to the 2% BOE target, but also for it to continue to fall further into territory that the BOE would like to prevent. Therefore in this scenario the Bank of England can respond with even more aggressive easing policies which would weaken the pound further.

At the same time, if inflation eases, that could help to ease the strain on consumers and give households some confidence, creating the conditions for an increase in domestic demand. This is a big if especially if the drop in prices is a result of recessionary pressures like a weak labor market, and contracting in bank lending, and a weak housing market.

GBP/USD - At The Precipice

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Last week, the GBP/USD pierced its lowest level since has been trading near July 2010 - a 17 month low - as market participants look at the prospects for the UK economy and see a bleak first half for 2012. At the same time the prospect for further money printing and the deterioration in the UK's largest market - the euro-zone - will keep the pound on the backfoot against the USD.

In the 2nd and 3rd scenarios outlined above it could lead to a break and a close below last week's lows (1.5230), opening up the potential for further declines in the GBP/USD.

The 61.8% retracement of the upswing from early 2010 to early 2011 comes in at 1.5190, below that we would be looking for the whole number of 1.50, and then the 1.4770.  Of course such a swing would play out over several weeks, if not months and not in a straight line, but the starting point would be a strong and convincing break of these recent lows.

Nick Nasad is the Chief Market Analyst at FXTimes - provider of Forex News, Analysis, Education, Videos, Charts, and other trading resources.