WISE MONEY

Today is all about inflation and just how much of the increasing price pressures are being absorbed by industry and retailers and how much is finding its way onto the consumer. The headline figure has come in at +0.7% m/m, +4.4% y/y, stronger than median forecasts +0.6%, +4.2% respectively which in the highest y/y rate since October 2008.

According to the Office for National Statistic the biggest upward impact on CPI came from housing, domestic heating bills and clothing.

In addition the PSNB in February at £10.280 billion, worse than median forecast of  £8.0 billion.

PSNCR came in at  £6.981 billion compared to median forecast  £4.2 billion.

Public finance data makes poor reading just ahead of the Chancellors’ Budget tomorrow.

Expect Sterling to pick up further today based on the high number but as to whether this is a correct move remains to be seen.

With growth expectations anticipated to be revised lower by the OBR, an immediate raising of rates looks likely to be counter-productive.

With Trichet again cementing the prospect of a rise in Euro rates next month, the single currency appears the likely recipient of short-term differential trades.

We are due no further relevant data today so Central Bank comment should prove to be the catalyst for additional forex volatility.

Japan’s Nikkei index opened over 2% higher after a holiday closure yesterday despite the nuclear situation remaining on high alert.

According to atomic officials, Fukushima Daiichi’s reactor 2 remains a danger as white smoke continues to drift into the sky from the plant.

The surrounding areas are now experiencing levels of higher-than-normal radiation up to 120 miles away.

Following last week’s intervention the JPY has been restored to relative normality against the USD and currently sits at 81.09.

The Pound has managed to reverse its four day decline against the Dollar this morning as data showed UK shop prices rose at the fastest annual rate in two years.The data has begun to reflect the VAT hike introduced in January and will probably rise again next month, and inflation hawks will be pointing to the continued rise in prices as justification of an interest rate rise by the Bank of England (alongside the current inflation rate being double the target….).

It is unlikely that the Bank will raise rates tomorrow, so it will be a wait again to the publication of the minutes of the meeting in two weeks to ascertain whether any more than the three current members voted for a rate increase.

With several research pieces in the market suggesting a Eurozone rate rise is a nailed on certainty at the next meeting, the Euro looks set to remain strong against both the Dollar and Sterling moving forward, even in spite of a rating downgrade of Greek government debt (again) and its banks yesterday and what looks a costly Portuguese bond auction this morning.

There have also been suggestions of large flows of Petro Dollars into Euros, continuing a general theme of diversification away from Dollars which is keeping the Euro well bid at the moment. In terms of Eurozone Data, it looks set for another quiet day with only German Industrial production set for release.

Today’s highlight is set to be the ECB meeting and subsequent statement and Q&A by ECB President Jean Claude-Trichet. As always the tone of his speech will be monitored extremely closely for any hawkish comments.

In particular any mention of upside danger in relation to the inflation rate will be interpreted as hawkish given Mr Trichet went to extraordinary lengths last time to avoid commenting on the above target inflation rate in a hawkish way.

This morning has seen Eurozone PMI data miss forecast slightly but any effect was more than offset by positive German retail sales and French unemployment data (which Trichet will undoubtedly cite when he talks about a broad based recovery in the Eurozone, laughable when you think about the state the periphery economies are in).

With the large amount of data and the ECB meeting this mornings Euro trading has been volatile, with the single currency up around half a cent against Sterling and the Dollar.

Fed Chairman Ben Bernanke had been the focus over the last few days with his statements to both houses (which we so similar he may as well had the first one taped and played back).

The real interest was in the Q&A session after the prepared address, in which Mr Bernanke talked about further QE and the Fed’s plan regarding short term interest rate.

The overall impression was that the Fed are not in a hurry to raise rates and that they will still not rule out further easing if the economic situation, especially in the labour market continues to deteriorate.

For the Dollar this meant mild softening as the speech progressed but all of Sterling’s gains yesterday afternoon have been given back in early trading this morning.

Bank of England monetary policy committee member Andrew Sentance has put further pressure on his colleagues with worries about high UK inflation.
He questioned claims that unemployment and spare capacity in the UK economy would slow down price rises, which he instead blamed on strong global demand.

Mr Sentance has voted for an interest rate rise since June, and was joined by another committee member in January.

Bank governor Mervyn King has said that inflation will remain high this year.

Consumer prices inflation rose to 4% in January – twice the Bank’s official target – largely due to rising commodity prices and the VAT increase.

Mr King said this week that the Bank expected inflation to remain higher-than-expected due largely to sharp rises in food and fuel prices.

In his speech to the Institute of Economic Affairs, Mr Sentance said that the “output gap” – economist-speak for how much less the UK economy is producing than its potential – is not as great as in previous recessions.

It is seen as an indicator of how fast the economy can grow without pushing up prices.

He suggested that measures of unemployment, domestic demand and business expectations supported his claim.

Unemployment is currently below 8%, whereas in during the recessions in the 1980s and 1990s, the rate had risen to over 10%, he said.

With relatively fewer people competing for work, he suggested that wages may start to rise more quickly, perpetuating higher inflation.

He also warned that businesses may “come to expect higher inflation on an ongoing basis, and the higher rate of inflation becomes deeply ingrained”.

High inflation to a large extent reflected “global forces”, he said, in particular the strong recoveries in Asia and other emerging markets.

He added that the exchange rate may have overreacted to the recession, adding to inflationary pressures, and favoured a modest appreciation in sterling.

Yesterday started with a big surprise as UK Chancellor George Osborne announced a hike in his special tax on banks. Mr Osborne plans to raise an extra £800m, but with the deal announced just days before bank bonus season begins in the city, political rather than economic reasoning seems to be governing motive behind the announcement.

Sterling reacted by falling all day against the Dollar and Euro, and the theme looks set to repeat itself and follow the line of least resistance after disappointing trade balance data earlier this morning and the lack of any clear direction going into the Bank of England rate decision tomorrow.

Rumours of a symbolic rate hike by the Bank are swirling (as they do every month) but one would expect Sterling to already have reacted if there were any substance to it.

No change to rates and the QE program is the widely expected announcement and with the bank wheeling out the Hawks last week for a media offensive on inflation expectations, one would think they would wait to see if this has had the desired effect rather than shocking the markets with a rate hike.

Three Federal Reserve members took to the dispatch box last night, peddling the party line that QE2 will be completed as planned and that further stimulus will probably not be needed.

The announcement pushed the yields on US Treasuries higher and was probably the reason for the Sterling retracement against the Dollar and the move through 1.36 in the Euro-Dollar pair.

We are in for another quiet day, but in terms of what to look for this later this week for the Dollar, Fed Chairman Ben Bernanke speaks this afternoon and we have the weekly jobs number on Thursday.

With the VAT rise and soaring energy prices, Wise Money expected high inflation numbers from the UK. However when they were released today at 9.30am the CPI and RPI figures didn’t disappoint.

CPI came in at 3.7% YoY; ahead of expectations of 3.3% which would have matched last months figure.

RPI was announced at 4.8% YoY with the extra 2.5% VAT adding to the other tax rises meaning the cost of living in the UK is spiraling.

That leads us onto an important question- what can the Bank of England do to get inflation nearer the target of 2%?

Previously, an interest rate rise would calm inflation and restore some stability to the price of goods.

Unfortunately, this approach is now extinct as the rises in commodities and tax are adding more pressure on the economy to grow.

Also, any big rise in the interest is likely to have a huge knock on effect in the housing market.

With many households enjoying almost interest free mortgages for the last 18 months, the country has maintained its standard of living rather than cutting back and paying off the mortgage.

This will come back to haunt the country as when those repayments grow, the cutbacks will begin.

On top of that, those who can barely afford to pay off there house will likely be forced to foreclose.

This will lead to a drop in the house market and prices could drop back to credit crunch lows.

The Governor of the Bank of England Mervyn King presented a very down beat assessment of the UK’s growth prospects this week.For the first time he mentioned there was an outside chance of a double dip recession during his inflationary report.

This sent the FTSE down 2.4% to 5245.21 and the pound fell for a third straight day against the Dollar down to a low of 1.5626 giving back all of last week’s gains.

In his Quarterly Inflation Report King highlighted that they are nowhere near considering an exit strategy, nowhere close to increasing interest rates and have now left the option open for renewed quantitative easing should the need arise.

This negative sentiment overshadowed the positive UK unemployment data which fell as the economy added workers at the fastest pace since 1989.

Unemployment as measured by the International Labour Organization fell 49,000 to 2.46 million in the three months up to and inclusive of June.

Employment jumped 184,000 to 29 million. Overnight sterling has shown relative strength versus the euro, moving over 1.5% against the single European currency and hit a high of 1.2182.

The Governor of the Bank of England, Mervin King, warned yesterday that a continued economic recovery was still unsure and that inflation is likely to remain above the 2% target for the next year.  King delivered a rather frank message to banks saying that their harsh treatment of corporate clients was leading to a “heartbreaking” situation in Britain’s small and medium sized business sector.

He said “It is a very tough job to build up these businesses and I do think that we need a pattern of finance that respects the need for these longer-term relationships.”

Mervyn added “They [small and medium-sized companies] may have had the same banking relationship for 60, 80 years and then suddenly out of the blue, comes a letter churned out by a computer which says that the terms of our relationship have changed.”

The bearish comments tempered Sterling slightly but that didn’t stop the Great British Pound hitting a fresh 5 month high against the USD following recent robust economic indicators and we are now trading at 1.5639 on cable.

Germany has banned naked short selling The euro came under pressure last night after Germany announced a ban on naked short selling of some securities effective immediately. Included in this bracket are the Eurozone Sovereign bonds as well as 10 of the biggest financial institutions.

The proposal was meant to calm the markets, but the Euro promptly dived below 1.22 against the greenback.

Naked short selling is when a trader sells a financial instrument, such as shares or bonds that they have not yet borrowed.

The Dow collapsed 114 points on the news as fears of a drop in funds for banks which could result in a scramble for cash as seen in the depths of the credit crunch 2 years ago.

Risk took a pounding with equities dropping, commodity prices falling and a rush to get hold of the “safe haven” Dollar.

Sterling slipped back on Tuesday as UK inflation data exceeded the central bank’s upper limit for the third time this year.

The Office of National Statistics said consumer prices rose by 3.7% in April compared to 3.4% in March, above forecasts for an increase of 3.5%. Of course, these figures require BoE Governor Mervyn King to write a letter to the new Chancellor explaining why this has arisen and what the Central Bank intends to do about it.

They are also fuelling concerns that potential monetary tightening as well as fiscal tightening may scupper the economy’s recovery following George Osborne’s comments that most of the 2010 spending cuts would be used to reduce borrowing.

King maintains his cautious tone as he continues to see “substantial” slack in the real economy.

Gordon Brown has headed to Buckingham Palace to ask the Queen to dissolve parliament for a May 6 General Election.

As we have mentioned  many times before, this election will be the most closely watched by the money markets for many years with most attention focused on the how any incoming Government plans to deal with the budget deficit.

All sides have already announced policies aimed at reducing the deficit but expect many more polices over the next month. Markets will closely scrutinise any declared polices and will also be looking for more details from existing proposals so expect increased volatility in Sterling pairs as markets digest the information.

After the announcement by Germany and France of a rescue package for Greece, Government debt stopped making headlines – for last week at least. The Euro continues to be weighed down by expectations of Sovereign risk of its member countries.

The Greek deputy prime minister clearly suggested that if borrowing costs for indebted countries do not decrease the next domino in the pack to topple will be Portugal. Quite how Mr. Pangalos thinks this pearl of wisdom helps any of the PIGS is not clear!

Overnight the Royal Bank of Australia has, as expected raised interest rates to 4.25%, its fifth rise in six meetings, sending the AUS Dollar higher against Sterling, which now trades at 1.64.