U.K. Inflation Surges; Economists Questioning BoE’s Deflationary Outlook

A better-than-than expected surge in U.K. Consumer Pricesraised questions about the recent assessment by the Bank of England that adeflationary trend was going to emerge because of the weak economy. 

A better-than-than expected surge in U.K. Consumer Pricesraised questions about the recent assessment by the Bank of England that adeflationary trend was going to emerge because of the weak economy. The BoErecently commented that the short-term rise in inflation over the past twomonths amounted to an aberration and that deflation was the real threat.

The GBP USD rallied into a major .618 retracement levelfollowing the news that British inflation rose in March to 3.4% from 3.0% inFebruary. This unexpected hike in consumer prices makes it unlikely that theBoE will increase the amount of quantitative aid at its next meeting on May6th. Gains could be limited today because of lingering concerns over thepossibility of a hung parliament after the May 6th election.

Speculation that Greece may require additionalrescue aid to finance its economy could weigh on the Euro the rest of thisweek. At this time, the EUR USD is trading better; this could change followingthe New Yorkopening. Additional factors that could hurt the Euro’s performance are ongoingtravel disruptions in Europe because of the volcaniceruption and the widening Greek government/German Bund spreads.

The spread of volcanic ash over Europecould develop into a major economic problem for the Euro Zone economy if theeruption turns into a long-term issue. This natural disaster could wreak havocon the economies in the Zone leading to delayed interest rate hikes and expectedfiscal tightening. While the rest of the world will be hiking interest rates,the European Central Bank may be forced to wait until the economy shows asustained improvement.

Although it was reported that German investor confidenceimproved more than forecast this month, the lingering Greece issuescould trigger a shift in investor sentiment especially if it is combined with aslowdown in the Euro Zone recovery. Greek borrowing costs have more thandoubled at the sale of 13-week bills. This prompted Bundesbank President AxelWeber to say that Greecemay need more assistance. At this time, investors seem to be looking for ashort-term fix to a long-term problem. Another call for financial aid from theEuropean Union could begin to erode confidence in the Euro’s ability tosurvive. All of this news indicates that traders should continue to look tosell rallies while maintaining a bearish bias for the Euro.

Higher crude oil and gold are helping to give the CanadianDollar a boost. In addition, traders expect Bank of Canada Governor Mark Carney tosignal that the central bank is poised to raise interest rates in the nearfuture. Although the BoC is expected to leave interest rates unchanged at 0.25%at today’s meeting, it is expected to present a more hawkish policy statement.Financial market traders are pricing in a rate hike on June 1 rather than theprevious guess of July 1. Traders cite the strong economy and the prospect offurther rate hikes as the main reasons why the USD CAD should continue to feelpressure.

The easing of tensions over the SEC/Goldman Sachs fraudlawsuit is encouraging demand for higher yielding assets which is helping toboost the USD JPY. Traders are also pressuring the Yen because of increasedoptimism that the global economic recovery remains on track. Since late lastweek, the Dollar appreciated against most majors as traders began to factor inthe possibility of a prolonged economic drawdown because of the disruption fromthe volcano, the possibility of a revaluation of the Yuan and the threat oftougher financial regulations.

Overnight India’scentral bank raised interest rates for the second consecutive month to 5.25%.It also ordered banks to set aside more cash in reserves. India isseeking to slow the highest inflation rate among the Group of 20 nations. Thismove by India broughtattention to the Pacific Rim area because it may mean than China may be next in line to raiseinterest rates.

Both the AUD USD and NZD USD are up this morning. Overnightthe Reserve Bank of Australiaminutes revealed that policymakers are concerned that a mining boom will fuelinflation. This prompted them to hike interest rates a 5th time in 6 months atits last meeting on April 6th. Based on the minutes, investors now feel a 6thhike will take place at the RBA’s meeting in May.

“The fact that the prospective rise in terms of trade waslikely to be noticeably stronger than had been expected was a factor suggestingthat it might be prudent not to delay” any further interest rate hikes. This commentfrom RBA policymakers triggered a sharp rise in the Aussie Dollar. Financialtraders also increased the possibility of a rate hike in May from 21% to 33%.

Today’s more hawkish than expected words from the RBA alsohelped increase speculation that the Reserve Bank of New Zealand is poised to shift to amore hawkish stance at its next policy meeting.