Sterling gains as sticky inflation suggests BoE will stay on hold

Tue Dec 18, 2012 9:14pm IST

* Sterling hits highest since late September versus dollar

* UK Nov annual CPI holds at 2.7 pct, above forecasts

* High inflation makes further QE from BoE less likely

* Dovish bias in minutes could show short-term weakness

By Philip Baillie

LONDON, Dec 18 (Reuters) - Sterling rose to its highest in more than two and a half months against the dollar on Tuesday after stubborn UK inflation added to expectations the Bank of England will avoid further easing for now.

The pound rose to as high as $1.6226, its strongest since late September. More gains could enable it to target the Sept. 28 peak of $1.6273 and the mid-September high of $1.6310. It was last up 0.1 percent on the day at $1.6215.

Traders said sterling was also lifted in thin trade by year-end demand for the currency from companies looking to hedge and from central banks.

UK annual consumer price inflation unexpectedly remained at 2.7 percent in November after a surprise jump the month before, which is likely to reinforce the central bank's concerns about price pressures proving persistent. The market consensus had been for inflation to dip to 2.6 percent.

Some analysts said the pound could lose some ground if the minutes from the bank's latest Monetary Policy Committee (MPC) meeting show a more dovish bias.

The minutes are due on Wednesday and could mirror earlier comments from Bank of England Governor Mervyn King that the UK will struggle to boost exports as long as the pound remains relatively strong.

"Sterling has been quite resilient in the last few sessions," said Audrey Childe-Freeman, currency strategist at BMO Capital Markets.

"The inflation numbers were a little bit of a non-event, MPC minutes and retail sales will be the focus this week, and if the minutes are on the dovish side ... we could see sterling more vulnerable."

BMO's Childe-Freeman said if the pound did show weakness after the MPC minutes, it could be an opportunity to buy, given sterling's recent momentum against the dollar.

Analysts at Citi said sticky inflation would make it more difficult for the BoE to extend asset purchases and added sterling was likely to track movements in the euro closely.

The euro was flat against the pound at 81.23 pence, trading down from Monday's near two-month high of 81.55 pence. Against the dollar, the euro was near a 7-1/2 month high.

BENEFITING BY DEFAULT

Analysts said sterling was also benefiting by default from expectations of aggressive easing measures in Japan, which would hurt the yen, and from last week's decision by the U.S. Federal Reserve to loosen policy further, which was weighing on the dollar.

"Sterling has been doing OK because it is one of the least bad of the major currencies. It is also benefiting from a perkier performance from the euro, but volumes are low and relatively small flows are having a greater impact," said Michael Derks, strategist at FXPro.

With the BoE likely to be on the sidelines, sterling could benefit from investors seeking better returns in a world where major central banks have cut rates to zero or near zero.

A Reuters poll conducted last week showed economists expect UK interest rates to stay on hold at 0.5 percent until at least mid-2014.

Still, investors will look to the minutes for clues on the chances of UK policymakers authorising more bond buying. Quantitative easing or expectations of more asset purchases by the central bank is usually negative for a currency as it increases its supply.

"The idea that there may be no more QE for now has impacted sterling at the margin," Derks said.

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