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Looming inflation could be good for GBP

Looming inflation could be good for GBP

Sterling had a largely indifferent performance yesterday, and indeed the day as a whole for the FX markets was fairly tranquil in comparison to the last few weeks. Retail sales data for the UK were as expected, and all of the data emanating from the US was almost identical to consensus forecasts. The notable exception to this was the Philadelphia Fed Index which showed a surprise uplift when expectations were for a drop. The Philadelphia Fed Survey is a spread index of manufacturing conditions within the Federal Reserve Bank of Philadelphia. European Union leaders agreed at their two day summit to set up a permanent bailout mechanism after the current European Financial Stability Fund expires in 2013. The agreement states ‘member states whose currency is the euro may establish a stability mechanism, to be activated if indispensable to safeguard the euro as a whole’, and ‘the granting of any financial assistance under the mechanism will be made subject to strict conditionality’. Still, some sort of facility post 2013 was always likely to be agreed and the finer details seem to remain sketchy. Nonetheless, equity markets have responded positively this morning. Back on home shores, the Bank of England seems to be awakening to the possibility that the current high inflation figures may actually be a signal of something more fundamental within the economy that needs to be dealt with, as opposed to being the unavoidable result of a number of short-term phenomena that will ultimately unravel. The Bank warned yesterday of the risk of a bond market crisis causes by rising inflation expectations or a fresh sovereign default panic. The bank also revealed that public expectations of inflation had risen sharply. Surveys showed that people thought prices would rise by 3.9% over the next 12 months compared with expectations of 3.4% in August. On the individual level, sharply rising food and clothing prices, the imminent VAT increase and higher fuel costs have all intensified worries about the cost of living next year. Inflation concerns are the major driver behind rising interest rate expectations, which over a 3 year time horizon have gone up over half a percentage point in the last 2 months alone. We await future Bank of England meetings to see how these concerns are germinating in the thoughts of the MPC.

Today is a fairly quiet day for data. In Europe, the German IFO is the main release, expected to show a small decline in December on the overall business climate measure, with a rise in the current conditions offset by a small fall in the future expectations measures. Also released this morning are second-tier releases on eurozone construction output for October and the trade balance in October.

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