Sterling drops after Tuesday's gains

Published: 17 February, 2011

Sterling dropped yesterday, eradicating gains after the Bank of England's Quarterly Inflation Report doused market expectations of interest rate hikes.

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The pound went on a strong run on Tuesday as consumer inflation figures hit 4%. This gave rise to an expectation of interest rate hikes much sooner than expected. However, Mervyn King yesterday accused the markets of getting ahead of themselves with talk of interest rate rises. The report very clearly downplayed the possibility of a rate rise and as such sterling dropped across the board. The report has clearly thrown water on the flames of rate hike speculation. It goes to highlight the fine line that the Bank of England are treading - high inflation on one side, but the threat of killing growth with interest rate hikes on the other. Until we have more clarity, sterling is likely to remain volatile.

In the euro zone, the euro strengthened against the Swiss franc after the Swiss government announced plans to deal with the strong currency. The franc has seen strength akin to the US dollar and Japanese yen as a 'safe haven' currency, so moves to devalue it helped the euro. The single currency also saw some support as a Portuguese buy back of bonds went smoothly, but concerns over the debt crisis are still lurking in the shadows.

The USA, producer price inflation showed a large jump fro the second successive time. This was attributed to a hike in the energy and food components of the figures. Despite this jump, other 'real' indicators of economic activity have surprised to the downside this week so any interest hikes in the USA are a way off yet. Out today we have consumer price inflation and unemployment claims.

Elsewhere, tension in the Middle East is still an issue, with the Israeli foreign minister calling Iranian plans to sail two warships through the Suez Canal "provocation". Many analysts feel that the potential ramifications on currency are too complex to call currently, so it is certainly something to keep an eye on.

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