Pound Hit by Inflation Report - But is the Sell-Off an Over-Reaction?

The pound sterling (GBP) looks set to close the week significantly lower than where it started thanks to confirmation by the Bank of England that its base interest rate will only be raised towards the end of 2015.

The sell-off in GBP comes despite the release of strong labour market data on the 12th of November which shows unemployment continues to fall and pay packets are rising.

The release of the November Quarterly Inflation Report by the Bank of England in the mid-week session confirmed, that despite an improving economy, there was no appetite to raise interest rates as there was no threat of rising inflation.

The sell-off has been deep, but in the opinion of one analyst we follow it may now be overdone.

As our latest quotes from the interbank market show, sterling is struggling at the time of writing:

• Pound to euro exchange rate conversion: GPP/EUR 0.04 pct lower @ 1.2590. The weeks high was seen at 1.2816.
• Pound to dollar exchange rate conversion: GBP/USD 0.24 pct lower @ 1.5741.The week's high was at 1.5941.
• Pound to Australian dollar rate conversion: GBP/AUD 0.16 pct higher @ 1.8044. High was at 1.8440.
• Pound to Canadian dollar exchange rate: GBP/CAD 0.13 pct lower @ 1.7836. The high was seen at 1.8077.

Please note that the above quotes will be subject to a discretionary spread by your bank, it can vary wildly from the market rate. If you are looking to make international payments we suggest being quoted by an independent provider. By tapping the wholesale markets they can offer up to 5% more currency in some instances.

Furthermore, as you can see there are huge differences between the week's highs and the current lows - you can take advantage of best rates and avoid negative currency moves by ensuring the correct risk controls are in place, learn more.

Is the Sell-Off in Sterling Now Overdone?

In the opinion of the team at Lloyds Bank the tell us the market reaction to the Quarterly Inflation Report (QIR) as exaggerated:

"The GDP projection was revised lower, however only marginally. Governor Carney’s comments were somewhat cautious regarding inflation and wage growth, and he showed no real urgency towards tightening monetary policy.

"However, we view there was little in the report that justifies pushing rate hike expectations further out. The OIS curve suggests the first rate hike is now fully priced by November 2015; which differs from the market implied rate expectation used for the Bank’s projections.

"We see potential for a turnaround in the re-pricing of rate expectations suggesting scope for a modest recovery in GBP. However, with sentiment towards GBP still, we may need a positive trigger to prompt a rebound."

The Bank of England Quarterly Inflation Report

Governor Mark Carney said he did not expect inflation to reach the targeted rate of 2% for three years.

The Bank also cut its prediction for UK economic growth in 2015 to 2.9%.

That said, the Bank said it expected average salaries to be growing by 2% by the end of 2015.

Carney has stressed there is no fixed date for the first Bank rate rise in the current environment, markets would have wanted to hear something a little more concrete that a rise was coming in the first half of 2015.

This will be a disappointment for those hoping for a stronger British pound in the near-term.

Negatives for GBP:

• Inflation forecasts are lowered sharply at the Bank of England. This has seen sterling's gains on the back of the employment data an hour prior slip away.
• No indications that an interest rate rise will happen before Autumn 2015.

Some positives for GBP:

• "Growth forecast only slightly weaker."
• "UK will outperform global competitors"
• "Wage growth picking up in real terms" 
• "Interest rate rises will be gradual and limited"

Business Will Welcome the Outcome of the  Inflation Report

Reacting to the Bank of England inflation report which expects rates to drop below 1 per cent, John Allan, FSB National Chairman said:

“Sustained low rates of inflation should delay any thoughts of a raise in interest rates. Although the reports predictions for European markets look gloomy, UK small business confidence remains high and this should continue to be supported by keeping interest rates low. Small firms welcome the supportive stance taken by monetary policy makers and hope to see it continue.”

Unemployment Report Gives the GBP a Shot in the Arm

The pound surged higher in the mid-week session, offering the best GBP levels of the week, after it was shown that earnings are starting to pick up pace.

Average Earnings including Bonus (3Mo/Yr) (Sep) grew by 1%, analysts had expected them to be stuck at 0.8%.

Average Earnings excluding Bonus (3Mo/Yr) (Sep) were shown to have grown 1.3%. Forecasts were for a reading of 1.1%.

Importantly this is the first time in five years that wages have been above inflation.

However the UK unemployment rate remains at 6%.

Osborne Welcomes Employment News

Chancellor George Osborne has welcome the unemployment figures are further evidence that the government's "long term economic plan is working."

Osborne says: "We've seen another big fall in unemployment, record numbers of jobs, and encouraging signs that pay cheques are beginning to rise faster than inflation. If we want to keep Britain on this path then we need to keep working through our economic plan."