UK inflation falls but so does Sterling

UK inflation data was released yesterday with the consumer price index (CPI) revealing a 4.2% increase for the year to December 2011, well down from the previous month's 4.8% and nearly a fifth down from its peak at 5.2% three months earlier. The figures were a timely reminder of the comments made by Bank of England Governor that inflation could tumble below this year to its 1%-3% target range. Whilst the falling rate of inflation does not guarantee an increase in the QE programme next month, it will ensure lively discussion of the topic by the Monetary Policy Committee.

The possibility of further quantitative easing has weighed on Sterling, holding it back on most fronts and sending it lower on some. By close of play Sterling was marginally lower against the Euro and US Dollar whilst falling further against the Australian, New Zealand and Canadian Dollars. Early trade this morning has seen it recover to Tuesday's opening level against the US Dollar but it is still not looking so clever against the Euro.

The Euro had another resilient day supported by inflation figures as well that were released at the same time as UK CPI. The Eurozone consumer price index went up by 2.7% in the year to December, higher than the European Central Bank's "at or just below 2%" target but an appreciable improvement on November's 3.0%.

The day's most strikingly upbeat assessment came in ZEW's survey of economic sentiment, which showed a dramatic improvement in investor confidence. In the Eurozone the score improved from -54.1 to -32.5 while in Germany it soared from -53.8 to -21.6.

There was a repetitive feel elsewhere with a steady stream of downward revisions by economic forecasters. The World Bank is the latest to lower its outlook. In June it predicted 3.6% growth for the global economy this year; yesterday that was revised to 2.5%. In the US the expectation of 2.9% growth has been shaded to 2.2%, while for the Eurozone the forecast has been slashed from +1.8% to -0.3%. Who would bet against more downward revisions?

Despite the downgrades, there was little sign of investors signing up to that gloomy viewpoint. Even a stand-off over the rescheduling of Greek government debt was not enough to dent the optimism.

Sterling's main hurdle today will be the employment data for November/December. Analysts expect unemployment to be steady at 8.3% with an increase of around 7,000 in the number of jobless claims. Weak figures would be likely to heighten concern for the economy and could send Sterling lower.