Sterling Strengthens as BOE Prepares to Tighten Monetary Policies

Posted January 15, 2010

The UK pound strengthened against the euro and the US dollar as inflation roared past a 2 percent target. The US is getting closer to a self-sustaining recovery which means stimulus programs will need to be withdrawn. The yen rose against the euro and US dollar. China begins exiting stimulus programs causing concerns growth will be impacted.

 

The UK pound strengthened against the euro as it closes in for a weekly gain not seen since October. The pound traded at 88.40 pence per euro making a 1.7 percent gain for the week so far.

The pound’s strength is due to speculation the Bank of England is about to end its bond buying program which is the backbone of the quantitative easing policy. As the recovery continues to gain strength, it is getting closer to the time when stimulus programs will need to be exited.

The pound also rose against the US dollar to $1.6299 which is a 1.7 percent gain for the week to date. Inflation in the UK has now risen higher than 2 percent which was the target set as an indicator that monetary policy will need to be tightened. The December inflation rate surged to 2.5 percent in December.

The Bank of England had considered raising benchmark interest rates as indicated by comments made by Bank of England spokesman Andrew Sentence to the Guardian newspaper. He said, “There are global influences such as oil and commodity and the impact of the exchange rate, which can lead to speed limits for the rate of growth.”  This is a complex way of stating that interest rates will be raised as one of the speed bumps to prevent runaway inflation. 

The bond buying program will probably be allowed to expire on 4-February-2010 after a final purchase of 25 billion pounds.

The euro is under increasing pressure and is being undermined as several member nations face continuing debt problems. Greece, Spain, Ireland and others are having a difficult time managing widening budget deficits. The Euro-zone will need to correct some of these ongoing financial problems which are undermining the euro and slowing the pace of economic recovery.

There are currently 16 member nations using the common currency.

The US is getting closer to exiting stimulus programs also. The Kansas City Federal Reserve Bank President, Thomas Hoenig, said the market is “healing”. He also said that the economic recovery is “sustainable even as the fiscal and monetary stimulus programs eventually wind down.”  As the recovery gains strength, the government is now faced with withdrawing $1 trillion in cash from the financial system. That is not going to be easy. Interest rates are expected to remain low through most of 2010.

As the UK ends its bond buying program the US will be ending its purchase of mortgage backed securities in March.

The Japanese yen rose to 130.84 yen per euro and to 90.81 yen per dollar. The yen strengthened against most major global currencies as investors retreated from higher yielding assets.  US retail sales for December unexpectedly fell creating uncertainty about the condition of the US recovery.  China has begun to implement tighter monetary policies causing additional concerns the change in policies will slow the nation’s economic growth. Many nations are looking to China to spur export growth.

 

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