Special FX Report - UK CPI and BOE policy minutes

By IBTimes Staff Reporter | August 17 2009 1:58 PM

GBP traded at a two week low versus the USD in Monday's trade pressured by declining equity markets and weaker UK house prices. UK house prices fell the most in eight months. The decline in house prices suggests that the UK recession has not yet ended and deflationary pressures may be increasing. Tuesday, UK July CPI will be released. Wednesday the BOE minutes for the August 5th/6th policy meeting will be released. The UK CPI report is key to the outlook for BOE policy. The BOE policy minutes are looked to for insight into the rationale for the August BOE policy decision and BOE policy outlook. UK headline inflation declined at an annual rate of 1.8% in June and dropped below the central bank's 2% target for the first time since September 2007. UK consumer prices are expected to weaken with consensus forecast that inflation rose at an annual rate of 1.5%. UK price pressures will likely remain subdued throughout the remainder of the year as economic growth is weak and the UK economic recovery is expected to be slow. The BOE is likely to continue with quantitative ease as long as inflation pressures remain low. A continued decline in UK inflation may encourage the BOE to expand quantitative ease.

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Last week there was a significant divergence between the FOMC policy statement and recent BOE policy action. The FOMC indicated that the US economy was leveling out and the FOMC plans to gradually reduce the purchase of bonds. This is the beginning of the FOMC's exit strategy from quantitative ease. The BOE elected to expand quantitative ease by Â£50 to Â£175 bln after the release of BOE's Quarterly Inflation Report which said inflation could fall below 1%. A soft UK CPI report may encourage the BOE to expand quantitative ease by another GBP25 bln at the next policy meeting on September 10th.

The BOE policy minutes will an important to gauge of how far the BOE may be willing to go in regard to quantitative ease and expanding the UK money supply and lending. There is emerging fear that the recent rally in global equities and commodities is not supported by fundamentals and that the global recovery may be at risk if central banks begin to look for exit strategies from quantitative ease. The main source of recent global growth has been government spending and easy central bank monetary policy. As government spending is about to lapse and some central banks are discussing possible exit strategies from quantitative ease, the global recovery is in doubt. Doubt about the global recovery and concern that central banks will exit quantitative ease too soonÂ has emerged as a key driver for the markets. If the BOE minutes signal the central bank is open to another expansion of quantitative ease it may help to relieve some of the fears about the global recovery and about central banks taking away liquidity too soon. GBP has been under pressure since the BOE announced the expansion of QE and extended losses as equity markets declined on doubts about the global recovery.

Equity markets have declined from a five month rally and USD is rebounding from the years low. Equity markets are pressured and USD supported by a pullback in risk appetite. Uncertainty about the outlook for the global recovery is emerging as the main driving factor in FX trade. Investors continue to try to balance safety versus risk appetite. There is concern that the recent run-up in equities and recovery in global economy was the result of stimulus spending and central bank quantitative ease. The greatest risk to the global recovery is central banks remove liquidity too soon and choke the recovery. Once stimulus is withdrawn the global economy may weaken and be at risk to a double dip recession. How the BOE responds to diminishing UK inflation risk is key to GBP price direction as the BOE is the least likely of the G-7 central banks to end quantitative ease anytime soon. GBP may experience additional selling pressure if UK inflation data is weak.