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GBP weakens

GBP weakens

European equity markets closed lower yesterday, with the UK’s surprise 0.5% fall in GDP in the fourth quarter helping to sour sentiment. While the ONS estimated that 0.5 percentage points of the drop was related to the cold weather in December, that would still leave the underlying position of the economy flat compared to Q3. That’s a weaker outlook than forecast by the MPC at the time of the November Inflation Report and is leading the market to question whether its post-Christmas fixation with inflation risks is appropriate. Indeed Governor King’s speech in Newcastle last night contained a substantial restatement of the MPC’s belief that most of the rise in the price level over the last few years was entirely down to temporary global and indirect tax shocks, and ‘if the MPC had raised Bank Rate significantly, inflation might well have started to fall back this year, but only because the recovery would have been

slower, unemployment higher and average earnings rising even more slowly than now.’

Euro-sterling rose sharply after the GDP release yesterday and has drifted higher since, currently it stands at 86.7 pence. December 2011 short-sterling futures fell 17 basis points in yield as interest rate hike expectations were pared back. The MPC Minutes today may provide further light on the balance of discussion in the Committee on inflation risks, with these pre- GDP minutes likely to contain somewhat tougher language on inflation.

The FOMC meeting tonight is unlikely to see any fresh policy moves. US data releases suggest the recovery is gaining some traction, but the level of unemployment remains high and the core rate of inflation remains low. So there is little to dissuade Committee members from continuing the QE2 program.

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