Currency watch: Inflation uncertainty

The pound has risen Lazarus-like in the past week as data begins to suggest that the inflation story is by no means over in the UK.

While inflation has been stuck at around the 4% level in the first quarter, we have to balance up the impact of the 4% depreciation we have seen in sterling in the past three months and the 25% increase in the price of oil.

Both have had a huge impact on inflation and will likely do so in the rest of the year as well, as the Bank of England’s latest Inflation Report confirmed.
 
Growth is still uncertain too, but leading indicators are showing growth in all sectors. However the weakness in consumer spending will cause fragility in the short term.

Expectations are that we will see business investment improve through the second half of the year, while impacts such as the tsunami on the one hand, and the Royal Wedding on the other, will continue to make data more volatile.
 
As for interest rates, the curve suggests that a rate hike is now not likely until December, which will come as a relief to homeowners, businesses and exporters (GBP will likely remain weak on exchange rate differentials) but the pressure on the wages of the "man in the street" is likely to be long and pronounced.

We are still looking for a rate rise in August however, as we believe that the Monetary Policy Committee will want to guard some semblance of credibility over its monetary policy decisions.

We also expect the summer months to see an increase in consumer spending and tourism, which should provide a welcome boost to the services sector.
 
Jeremy Cook, chief economist at World First foreign exchange, 13.05.2011