High inflation fails to support sterling’s gains

Despite UK inflation meeting expectations and remaining steady at an annualised 3.1% in September, the 10th consecutive month above the Bank of England's target has failed to translate in sterling's favour.

Having gradually fallen from April's high of 3.7%, the Consumer Price Index (CPI) has now been stuck at 3.1% for the past three months, running against the stance of the Bank of England. The data leaves little doubt that Andrew Sentance will have stuck by his call for an immediate interest rate rise and is likely to have dissuaded the majority of the MPC  from siding with Adam Posen's argument for further quantitative easing.

Following the latest release of inflation data, sterling initially edged up to an intra-day high against the euro just shy of 1.15 but has since dropped back to nearer 1.1450.  In failing to drop back below 3.0% yet again this month, inflation provides a particularly strong argument to keep the Bank from extending their QE budget.

Duncan Higgins analyst at Caxton FX says "High inflation is about the only factor currently staying the Bank's hand in terms of extending monetary easing. The Bank is maintaining its medium term view that prices will start to decline, but clearly certain policymakers are not content with the apathetic response to inflationary pressures."

Higgins adds "A single monthly reading is unlikely to impact on the Bank's overall stance, but it may have prevented any further members from voting in favour of additional stimulus. Before a call on this question is made, the Bank will want to see an update on the indicators of economic growth. Concern that growth will slow over the coming months is at present the most prominent factor in the argument for QE2 and is likely to continue to weigh on sterling's prospects."

Higgins continues "Whilst high inflation may have prevented any change in policy at the last meeting, the Bank is looking to the medium term and weak indicators of economic growth are keeping QE very much on the table."