UK inflation soars to 4.5% and Sterling benefits

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Yesterday's UK inflation rate reached the second highest level since the Bank of England took responsibility for inflation since 1997. In the year to April, consumer price inflation (CPI) reached 4.5%, up from 4.0% in March and exceeding the markets expectations for a figure around 4.1%. The initial reaction in the currency markets was to buy Sterling in anticipation that the monetary policy committee (MPC) will have to do something other than ignoring such an high level of inflation and raise interest rates before the next inflation report in August.

As inflation remained above the 1%-3% target 16th consecutive month the governor of the Bank of England, Mervyn King, had to write another letter to the Chancellor explaining why inflation was so high. The letter said inflation was driven higher by energy and import prices and the increase in VAT and that is likely to rise further over the next few months as petrol prices and utility bills increase. The letter went on to say their impact will be removed from the calculation next year so there is no need to raise interest rates and with that, Sterling's rally ceased.

Despite that, on the Foreign Currency Exchange markets Sterling closed the day up against the US Dollar, the Canadian Dollar, the South African Rand and steady against the Euro. Sterling's gains against the US was due to some dismal US data; US housing starts and building permits both fell in April and industrial production was flat. 

Both the Bank of England and US Federal Reserve publish minutes today from their most recent monetary policy meetings. There is also the the latest UK labour market figures today.

The Bank of England MPC meeting on 5th/6th May was the last for MPC member Andrew Sentance, who is expected to have voted again for a 0.5% rise in interest rates. It is likely that he was joined on the hawkish side again by MPC members Dale and Weale, who have been voting for a smaller 0.25% hike. 

The focus for the markets will be on the sentiment of "neutral" voters for signs of greater concern about the above-target inflation level.