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Strong sterling cools BoE inflation forecast

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The strength of sterling has played “a significant role” in the Bank of England’s thinking over inflation projections, says Axa’s David Page.

The Bank said today the stronger pound trajectory over the past months could cause a delay in the rise of inflation in the UK.

In its latest inflation report, released today, the Bank stressed the fact sterling has appreciated by 3.5 per cent since May, as well as rising in the past couple of years, will likely push inflation down in the near term.

The MPC minutes say: “In light of the reduction in oil prices and appreciation of sterling over the past three months, it appeared that the increase in inflation over the following year would be more gradual than had previously been supposed.”

Axa Investment Managers senior economist Page says sterling has played “a significant role” in the Bank’s thinking over inflation projections.

He says: “Sterling is clearly having a significant role in the bank’s thinking about the development of inflation. They’ve suggested they’ve downgraded to some extent the path of inflation over the near term…they think that is a more accurate way of treating the situation and we will see how that goes through.”

The MPC report also says: “To the extent that the appreciation of sterling could be expected to weigh on inflation for a persistent period, the corresponding pickup in domestic costs necessary to return inflation to the target within three years would be greater.”

“The movements in sterling over the course of 2015 had been correlated with changes in the interest rate differentials paid on sterling and foreign currency assets, although the scale of the change in the exchange rate had been much larger than implied by the change in interest differentials alone,” the MPC minutes state.

“The recent appreciation of sterling was therefore likely to represent an additional tightening in financial conditions over and above the steepening of the sterling yield curve over the past few months.”

JP Morgan Asset Management chief market strategist for Europe Stephanie Flanders says, unlike many major economies, “the UK is not trying to recover on the back of a weak currency, but the Bank does not want investors to think sterling is a one-way bet”.

BoE governor Mark Carney pointed out in his press conference on the UK outlook today that sterling has risen 20 per cent on a trade-weighted basis since March 2013.

Flanders says: “With monetary policy still extraordinarily loose in the major developed economies, the upward move in sterling in the past two months shows how even a modest move in rate expectations can have a dramatic impact on the currency.”

The inflation report had had an immediate impact on sterling with the British currency falling 1 per cent against the dollar and the euro today.

Flanders says: “However, we do not believe this is the start of a sustained move down in sterling given the broadly upbeat tone of today’s statements about the economy.”

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