The Pound rallied against the Euro

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The Pound rallied against the Euro yesterday, briefly trading above the 1.14 level, while the UK currency also made gains versus the majority of the 16 most-actively traded currencies, after a government report showed that UK inflation accelerated by more than initial forecasts at 4.4%. Consumer price growth makes it less likely that the Bank of England will loosen policy further and implement further quantitative easing measures to support the economic recovery.


The Bank of England governor Mervyn King remained steadfast in his belief that inflation would naturally slow below the 2% target over the coming months. Concerns surrounding the global economic outlook has hurt growth prospects, while the turmoil in Europe poses a risk to the UK. The Euro also weakened against the U.S Dollar, following a report that Euro-zone economic growth slowed by more-than-expected, adding to concerns that peripheral economies will struggle to manage debt levels.

The Pound rose 0.5% against the Euro, registering its fourth gain in five days, while the UK currency also rose for a fourth straight trading day versus the U.S Dollar. Investors are betting that the Bank of England will keep interest rates unchanged until after July 2012, according to the Sterling overnight interbank average. As recently as February, the data indicated that traders were betting on a rate increase this May, which gives some sense of how the economic outlook has weakened over a very short period.

The BoE governor Mervyn King said in a public letter to the Chancellor George Osborne that "recent developments in world stock markets and in the Euro area are of particular concern. There's a risk of severe stress and dislocation in financial markets and, were this risk to crystallize, it would have a significant impact on the UK economy."

With inflation rising to 4.4%, the Bank of England can't afford to consider embarking on further quantitative easing measures at this time, but a rate increase to quell consumer price growth could have a further damaging effect on the economy. This poses a difficult dilemma for the Bank of England and officials will likely continue to adopt a wait-and-see approach.

The Bank of England will publish the minutes from the August policy setting meeting this morning, after officials left interest rates on hold at a record low again this month. The UK economy is expected to expand 1.2% this year, compared with a projected 3.4% in Germany and 1.8% in the U.S. It will be interesting to see if the minutes reveal that policy makers discussed the prospect of adding to bond purchases this month and speculation would tend to weaken the Pound.

The Pound initially found support on dips towards 1.6320 against the U.S Dollar and peaked around 1.6470. The latest employment data will also be released this morning and will probably show the claimant count increased again last month, while the jobless rate remained unchanged at 7.7%. UK average earnings for the three months through June are also expected to remain the same at 2.3% from the first quarter.

EUR/USD

The Euro weakened against the majority of the 16 most actively traded currencies yesterday, after leaders in Germany and France met and rejected the issuance of bonds by the Euro-zone to contain the sovereign debt crisis. The French President Nicolas Sarkozy said France and Germany are working on "ambitious" joint plans to defend the Euro.

The Euro declined following the comments, slipping 0.4% against the Dollar, after peaking at 1.4477, the highest level since July 27th. The Swiss Franc weakened again as the SNB look to implement further measures to quell the currency's advance. The Franc declined against the Dollar and the Euro, after U.S industrial production climbed, reducing the appeal of the Franc as a safe haven.

The Euro-zone economic data was weaker-than-expected, as gross domestic product expanded just 0.2% in the second quarter, despite initial estimates of 0.5%. The U.S housing data was close to market expectations with starts dropping marginally for July. Credit ratings agency Fitch affirmed its AAA rating for the U.S and also maintained a stable outlook, which is in stark contrast to Standard & Poor's.