BoE, Inflation and Sterling

<p>Wednesday’s release of the Bank of England quarterly inflation report is expected to show another downgrade of growth prospects. 2013 GDP may be revised to […]</p>

Wednesday’s release of the Bank of England quarterly inflation report is expected to show another downgrade of growth prospects. 2013 GDP may be revised to as low as 1.5% from over 2.0% in the May report. The BoE will likely reiterate its forecast that CPI will fall below the 2.0% target before year-end from its current 2.4%.

The pace of decline in UK inflation is nearly identical to that during 2008/2009. CPI peaked at 5.2% in September 2008 before tumbling to 1.1% exactly 12 months later. The pattern repeated when CPI made another September peak of 5.2%, this time in 2011. If the pace of declines remains in tandem to that of 2008/2009, then we could see CPI reach as low as 1.0% before year-end.

One fundamental factor standing apart from 2008/2009 is the decline in energy prices. Unlike in 2008/2009 when oil prices plunged by over 50%, a double-dip of 30% occurred in 2011 and 2012. Yet any decline in energy is more than offset by the 36% rise in wheat prices and 23% increase in corn so far this year. This would offset the negative impact of slowing energy prices, especially as the sterling index is off 14% from its May highs.

BoE Balance Sheet: Now vs. then

Aside from comparing inflation and energy prices, bear in mind the BoE’s balance sheet — at a record £376 bn — is up 54% from autumn 2011. The increase was inversely related to the sharp drop in inflation from 5.2% to 2.4%. As inflation nears the 2.0% level and the UK economy shows little signs of exiting the recession in the midst of intensifying austerity and slowing global macro dynamics, the case for further QE should remain, as will the forward-looking negative bias on the British pound.

Technically, GBP/USD faces a rare confluence resistance, whereby the 200-day moving average at 1.5730 is near the 200-week moving average of $1.5710. The fact that both the 200-day & 200-week moving averages have acted as visible trendlines, raises the relevance of this level and reduces the market’s determination to extend bids beyond 1.5770s, near the 100-day moving average. On the downside, 1.5480 remains the required break-target by the bears to step up any fresh selling. A weekly close below 1.5480 could pave the way towards 1.5280 as the focal point for the next selling pressure.

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