The conflicting pressures on the Bank of England, government and currency have been very clear to see over the past 24 hours. The inflation data and gilt auction shows that there are costs to a policy of aggressively cutting interest rates and raising government borrowing sharply, especially if international confidence is lost. Credibility will be a key issue over the next few weeks and Sterling confidence is liable to deteriorate in the short term. Overall, the downward correction is liable to extend towards 1.4450 against the dollar.
The UK inflation data released on Tuesday will tend to increase Bank of England caution over an even more aggressive monetary policy and any shift in policy stance towards the currency€™s level may tend to support Sterling.
There will also, however, also be the risk a further deterioration in medium-term sentiment towards the economy with the possibility that Bank of England credibility will be damaged.
The central bank warned that the government should not boost fiscal policy significantly further in the forthcoming budget given the debt stresses and rapidly rising budget deficit. The warning will tend to undermine currency support given that fiscal fears are already an important factor in damaging sentiment.
Sterling peaked at a six-week peak near 1.4780 against the dollar before correcting weaker while it also appreciated to 0.9170 against the Euro. Sterling weakened back towards 1.46 against the dollar on Wednesday and also dipped to 0.9260 against the Euro.
The potential vulnerability was illustrated by the latest gilt auction as the bid/cover ration weakened to 0.93 from 2.03 at the previous auction. The very poor result will increase fears over structural vulnerability and weak capital inflows.