GBP continues to underperform pressured by speculation that the BOE will maintain its accommodative policy longer than other G-7 central banks and may elect to expand quantitative ease if inflation continues to decline. GBP has also been pressured by concern about rising UK government debt as the UK increased spending to try and boost the UK economy. UK GDP debt ratio is approaching 57%. The Center for Economics and Business Research (CEBR) says that the BOE may keep interest rates at the record low 0.5% for the next five years and elect to expand its asset purchase plan beyond the current £175 bln. UK PM Brown warned that an early exit from quantitative ease could imperil the UK recovery and he tried to reassure investors that the UK government has a credible budget deficit reduction plan. GBP traded lower Monday pressured by the CEBR report and Browns comments.
Last Thursday the BOE elected to keep monetary policy unchanged and maintain its current level of asset purchases at £175 bln. The BOE indicated that it will take another month to complete its current asset purchase program and that the scale of quantitative ease will be kept under review. This means that the November BOE meeting will be critical in determining whether the BOE will expand quantitative ease. Expansion of quantitative ease will largely depend on upcoming UK economic and inflation data. Recent UK economic data has been mixed with service PMI at a 15 month high and consumer confidence at a one year high but industrial production dropped sharply last month. UK CPI for September will be released on Tuesday October 13th. UK August CPI rose 1.6% compared to 1.8% in the prior month. The smaller August inflation rise reflects lower utility bills and food costs which were offset by higher energy costs. The BOE forecasts that UK CPI will fall below 1% in the months ahead before rebounding and remain below target for the next three years. Note that UK inflation rate has been higher than the BOE has expected and CPI does not the match BOE forecast. This could have implications for BOE policy. If UK CPI continues to fall below the BOE's 2% target the data may encourage the BOE to expand quantitative easing measures. If inflation begins to rise it will encourage the BOE to maintain its current level of asset purchases and make it hard for the BOE to expand quantitative ease. UK September CPI is expected to rise 1.3% y/y compared to 1.6% last month with core CPI expected at 1.7%. The BOE will be closely monitoring the core CPI rate.
EUR/GBP traded at a six month high Monday. The EUR/GBP cross may experience further gains if UK inflation continues to moderate and speculation intensifies that the ECB will hike rates before the BOE. The ECB is expected to begin an exit from nonconventional policy mid 2010. CEBR says the BOE will leave interest rates at record low at least until 2011. The divergence in ECB and BOE policy outlook favors buying of the EUR/GBP cross.