Interest rate rises ahead for GBP?

The major piece of news yesterday for the UK, immediately leaped upon by the wider press in this climate of VAT rises and soaring fuel prices, was the CPI figures that showed inflation coming in higher than expected for December. Against a forecast increase of 3.3% year on year for December, inflation came in at 3.7%. As ever a range of one-off influences can partly excuse the rise. The coldest December in 100 years will probably have pressured fresh food prices higher, not least as retailers sought to extract more margin from consumers worried about supplies over Christmas. And some of the rise in other prices may reflect retailers passing through the VAT hike ahead of schedule. But the worry for the MPC is increasingly these justifications are looking thread-bare. Unsurprisingly, markets, and the wider public, are now almost concrete in their belief of an imminent raising of interest rates in the first half of the year, and Sterling reacted accordingly, hitting a two-month peak against the Dollar and rising above 1.60.

Sterling didn’t experience the same strengthening against the Euro, which had a great day on the back of the ZEW index of German economic sentiment, which jumped from 4.3 points in December to 15.4 points in January. This was double the reading expected, and the highest in six months. Along with last week’s hawkish comments by ECB President Trichet, and another positive auction of Spanish debt, the single currency gained ground even as it became increasingly clear that there would be no quick agreement between EU finance ministers over enlarging the regions bailout fund.

This mornings UK labour market data came in evens, the same figure as last month and so has had litle effect. Yesterday’s inflation data however means that the market will be less interested in labour volumes, but instead will focus on average weekly earnings, looking for signs that the rise in prices is feeding through into wages. Consensus is for average weekly earnings in the three months to November to remain unchanged at 2.2% on the same period a year ago, with underlying earnings also stable at 2.3%. Any sign that there is upward pressure on wages will only harden market concern that the MPC is abandoning their statutory inflation target, preferring to track some nominal GDP growth rate instead.

In the US, housing, mortgage and construction data dominate the calendar.