Market Focus for 4 FEB 2010: Bank of England Rate Decision

Interest rates and quantitative easing program to stay the same
Higher-than-expected CPI has stoked inflation fears
Predictions for rate rise range from April 2009 to 2010

While the rate decision for the Bank of Englandís Monetary Policy Committee (MPC) was rather straightforward in January, the latest data to come out after the meeting on January 6-7 has highlighted the risk of inflation in 2010 and will pose a dilemma for the central bank as it has to balance the prospects of reining in price rises and keeping the economic recovery alive.

Interest rates in the U.K. have remained at a record low of 0.5% since March 2009 and they are set to stay there while the MPC is also expected to end its quantitative easing program after buying 200 billion pounds worth of gilts and other assets. There has been some speculation, including ahead of the last meeting, that an extension to the asset purchasing program would be implemented due to signs of weakness of the U.K.ís climb out of recession, especially in the labour market and concerns over the strength of the economic recovery after Q4 GDP rose by only 0.1% compared to the marketís expectation of 0.4%.

However, year-on-year CPI rose from 1.9% to 2.9% in December, well above economistsí forecast of 2.4% and also substantially above the Bank of Englandís inflation target of 2.0%. This has sparked rumours that interest rates may have to be increased as early as April 2009 (or in the middle of the year), as opposed to the fourth quarter of 2010 or early 2011 in a somewhat more bearish scenario.

Sterling fell to as low as 1.5851 (holding above support at 1.5833) and the effect of the interest rate announcement is likely to have a neutral to mildly bullish effect on the gbp/usd rate, especially if the MPC does not announce any extension to its asset purchasing program, which would keep gbp/usd inside the near term range of 1.5833-1.6458. An unexpected extension (or restructuring) in regards to quantitative easing or the framework for remunerating commercial banks reserves will pressure sterling and test the chart supports at 1.5833 and 1.5706.


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