UK inflation figures were published this morning showing that price rises are still rocketing. 

Normally, a strong inflation number indicates that interest rate increases could follow and thus we see a gain in the value of the currency.

However, we are not in normal market conditions and the uptick in inflation will not be reflective of future rate increases as the Bank of England expects inflation to fall back towards 2% in time.

The current weak growth that is threatening the UK’s recovery continues to overshadow inflation and with the risk of a double dip recession still lurking, the BoE has no choice but to keep interest rates low.

The fact that the number was higher than forecast is actually a negative for the pound and we have seen the pound dip against the US Dollar and slightly against the Euro since the numbers were released.

Late in yesterday’s trading, the Euro lost value as pessimistic comments from Angela Merkel dampened the positive mood that was building towards the October 23 summit.

Wise Money expects the euro and the US Dollar to be volatile ahead of the summit as the Eurozone leaders hammer out further bailout measures to support the single currency and some of its ailing economies.

Data yesterday showed that UK inflation continued its upward march through August with the benchmark CPI figure rising to 4.5% over the past 12 months.

The Bank of England expects the rate to keep rising towards the five percent level, before peaking and then moving back towards the two percent target.

Whether you chose to believe the Bank given its recent forecasting record is a mute point.

On top of the shaky CPI estimates the forecast may be further derailed if we find out that further stimulus is back on the minds of the MPC when the minutes from the last meeting are released in a few weeks time.

Given that the recent quarterly inflation report presented the probability of further stimulus as quite low, the recent calls for another round of easing by the Bank could counteract the downward pressures to inflation that are currently expected.

Or we may see inflation stay stubbornly high and so contrary to BoE forecasts.

UK Jobless claims rose by slightly less than expected, pushing Sterling up slightly against the Dollar in early trading this morning.

The crisis in the Eurozone continues to morph quicker than policy makers can react to it.

French banks suffered huge swings in share prices yesterday as first fears over their ability to raise short-term Dollar funds sent prices down almost 10 per cent before statements denying the rumours caused a rebound of epic proportions.

BNP Paribas eventually closed up 7.2 per cent yesterday but there is no rest bite for the Gallic lenders this morning with Moody’s, the ratings agency, announcing a downgrade for SocGen and Credit Agricole with BNP Paribas placed on review.

Alongside this, we still have ongoing worry over the potential default of Greece.

German Chancellor Angela Merkel tried to reassure the markets after several of her political partners openly questioned if Greece was insolvent and/or should leave the Euro over the weekend as yields on 2 year Greek bonds fully departed reality and traded over 95% (remember when they were 35% and everyone was so worried?).

The ongoing problems have not stopped the Euro from retracing some of the move from Friday and Monday. The sheer size of the move means we may see the Euro strengthen slightly through the rest of the week.

Under the spot light this week are retail sales, inflation, industrial production and regional manufacturing surveys which will offer some direction to the Greenback and it is likely that the data over coming days will look less negative than in past weeks, giving the US Dollar some support. 

On the other hand, EUR/USD continues to struggle, falling below its 200 day moving average in spite of positive news from Germany (rejection of bills in the constitutional court) and China assisting the Italians with their bond programme yesterday.

The ECB did not help the EUR’s cause however, with the change in its stance to a more balanced assessment of risks from its more hawkish stance previously.

However, the real damage occurred as speculation of a Greek default intensified and ECB hawk Stark resigned from the ECB council, highlighting the divisions within the governing board.

This week attention will remain on Greece as negotiations between the Troika (ECB, EU and IMF) and Greek officials resume.

Ahead of the talks Greece approved a further EUR 2 billion in austerity measures over the weekend but nonetheless, despite denials by Greek officials speculation of a debt default will continue to hammer the EUR lower.

So far today we had CPI data which came in at 4.5% from 4.4% in July according to figures from the ONS.

This sits well above the Bank of England’s target rate of 2% which is expected to return back to target within two years.

The ONS blamed continued pressure in energy prices as well as clothing& footwear but accepted some relief in transport services and recreation in particular game consoles helped to offset further price rises.

Meanwhile, the Bank of England’s monetary policy committee held Britain’s base rate at 0.5% despite inflation recently climbing to 4.5% – more than double the Bank’s 2% target.

This has been driven higher by the rising cost of essential items such as food and fuel.

A rate rise could help to bring inflation down towards the target, however analysts praised the move saying “stability was key to the country’s recovery”.

The BoE has warned that inflation will rise above 5% later this year and remain above target through 2012 before dropping off in 2013.

Yesterday brought strong US jobs data and the positive figures were welcomed in the US which has seen its economy hits the skids recently.

Weaker data paired with an ever growing debt pile have seen the Greenback slide over the last 3 months.

This week though has seen a revival in the Dollar as investors look for the safe havens to avoid the ongoing debt issues.

The market is almost unanimous in expecting Trichet to use the ‘strong vigilance’ phrase in his conference following its surprise omission last month.

This will be interpreted as a signal that the ECB will raise rates in July.

The Euro has accordingly been bought up versus most other major currencies over the past few weeks and here lies the possible problem.

If, by chance, the ECB deem the slowdown in the Eurozone economy and the strains currently being imposed upon the peripheral countries’ finances as being more of a concern than recent rises in, then the market might be in for a surprise.

This brings risk for the currency from the ECB statement to the downside and might stir the market to sell the Euro ahead of both the rate decision announcement and the press conference.

Sterling and UK interest rates both had an interesting day yesterday, firstly suffering as a result of comments from Moody’s concerning the longevity of the country retaining its AAA sovereign rating status.

The agency highlighted the dangers from George Osborne failing to follow through on his deficit cutting pledges and also a possible decline in the rate of the UK’s economic recovery as reasons for a downwards adjustment in the rating.

The UK was not alone in the firing line however with Fitch joining Standard & Poor’s in signalling a possible downgrade of the US sovereign rating should their law-makers not come to some agreement on increasing the country’s debt ceiling.

It is difficult to see either move happening but the respective situations, in the UK especially, are finely balanced.

He also said that he is satisfied that the economic conditions in the US remain positive for growth, even in light of the recent weak employment and manufacturing data over the past few weeks.

Mr Bernanke continued to suggest the US economy is producing well below its potential but the current weak data flow is a “soft patch” and there would be a pick up in activity in the second half of 2011.

US stock markets immediately reversed small gains once the Fed Chairman began his talk and finished down on the day.

The US Dollar also strengthened on the news and looks set to continue that path today with Bourses in Europe opening the day down and the risk-on risk-off see saw continuing to play out across the markets.

With the ECB not likely to raise rates this Thursday, the closely watched press conference by ECB President Jean-Claude Trichet becomes the potential market mover.

The market seems to be suggesting there is a high probability that Mr Trichet will indicate a rate increase in July.

In the strange world of Central Bank communication, he will not say this directly but indicate this by mentioning “vigilance” when talking about the Banks stance towards inflation.

Given the size of the move in the Euro against the Pound and Dollar there seems to be a big chance that the market will be disappointed.

It looks set to be a busy day for the Euro.

Also due is Italian unemployment and CPI, French Consumer spending and PPI and the Euro wide CPI and unemployment rate.

Given the perceived hawkish stance of the ECB, the CPI data should be watched closely.

A rate rise is much more probable in the Euro zone than the UK or US, and above target CPI will only increase the likelihood of another rise in interest rates in the next couple of months and that should begin to be reflected in the Euro rate against Sterling and the Dollar over the next couple of weeks.

The U.S. data calendar is also busy this week.

The highlight, as ever, is the non-farm payrolls number on Friday but we also see Consumer Confidence and ISM Manufacturing figures and Wednesday and Thursday.

As we come to the end of QE2 the US numbers are increasingly important in trying to gauge whether the Fed will embark on another round of monetary easing or begin in selling back some of the securities sitting on its massively enlarged balance sheet.

This has massive ramifications for the path of the USD – more easing should, in theory, be USD negative in the long run as more Dollars are created by the Fed, the converse is true if the Fed begins selling.

There are further complications, the risk is that the Fed begins monetary tightening to early and the recovery begins to stall, in which case QE3 may happen anyway.

It is this uncertainty that is weighing in the US Dollar currently.

Strong UK retail sales figures, driven by warmer weather and the royal wedding, gave Sterling a lift in early trading yesterday.

Once the dust had settled the consensus was that April’s data is likely to be just a blip in an otherwise disappointing trend.

Also yesterday the Bank of England’s chief economist, Charles Bean said the bank had accepted higher than target inflation in an aim to rebalance the economy towards exports and business investment and he suggested that to achieve their two percent target would have required a markedly higher bank rate and with it a higher level for Sterling.

What he was implying is that if the Bank had raised rates, the squeeze on consumers would have been worse than is now, and shows just how tight the path the bank is currently walking actually is. No Sterling data is due today and the next important figure is UK GDP figure early next week.

A large amount of data on the US economy was released yesterday.

Better than expected weekly jobs data and a very disappointing Philly Fed reading caused Dollar gyrations for most of the afternoon.

The market seems to be trying to work out what the end of QE2 means for the Dollar at the same time as trying to guess from the data whether there may be further on the horizon – and the result is high volatility across the Dollar pairs.

Next week sees US GDP figures from the first quarter so we may finally get see the market clarity of what direction it expects the Fed to pursue.

The main points from May’s MPC meeting were as expected and indicated no change in voting from April’s outcome.

However, the meat on the bones was always going to be the interesting facet, and so it proved.

The minutes suggest that the majority of members on the committee remain in no hurry to raise interest rates and although it is apparent that a wide division in views still exists, it is obvious that more members remain concerned about the downside risks to growth than about the dangers of stubbornly high inflation.

Moreover with the most hawkish member, Andrew Sentance, now set to be replaced by Ben Broadhurst, who seems to have a more balanced view on the economy, the make-up of the MPC would seem to be moving even further towards unchanged policy.

As a result, interest rates in the UK appear set to remain at the current low levels until the Autumn at least, with the November meeting now touted as the favourite for a tightening of policy.

The FOMC minutes, like those of the MPC, produced nothing earth shattering as the Fed Chairman, Ben Bernanke, had already prepared the market for a less dovish stance in his first press conference although again, the detail, when you dug down, was more revealing.

Markets were surprised by the extent of the discussions concerning exit strategies with officials outlining several guiding principals for the process of normalising monetary policy.

It was also clear that the majority of voting members favour raising interest rates prior to any asset sales as a means of tightening liquidity conditions.

Moody’s were also active, downgrading by 1-notch the credit ratings of the 6 largest Danish banks on fears of declining financial resilience.

None of this dented the Euro’s continued strength however with Asian markets preferring to focus on a report in The Times of China’s continued appetite for Eurozone sovereign debt as a means to diversify its foreign currency reserves away from the Dollar.

As expected, the Bank of England’s loans interest rates setting committee voted 6-3 in the last meeting where they left rates unchanged at 0.5%.

The minutes also gave us a view into how the MPC is thinking with members Weale and Dale seeing a case for a rate hike as “finely balanced” given the weak real economy and uncertain outlook.

Their outlook for inflation has not changed over the month with near-term looking worse than February, but likely to fall in medium term assuming the banks rate rises in line with market yields.

Going back to yesterday, the UK inflation data was woeful and although the pre-release rumours had pushed up the expectation, the +4.5% headline and +3.7% core levels were both higher than expected.

The headline was the highest rate since October 2008 but more significantly, the core number is now higher than it has been at any time since records began back in January 1997.

Interest rate futures and gilts both moved sharply in sympathy with the ‘higher rates sooner’ scenario and Sterling jumped across the board.

The strength however was very short-lived and the Pound ended up weaker on the day.