$2 Cable – Driven by the Bank of England Letter

The pound has moved above $2 for the first time since the currency crisis of 1992. This surge came after the latest UK CPI report which shows inflation is now above 3 percent. This increase above the inflation target requires that the head of the Bank of England, Mervyn King, to send a letter to the chancellor, Gordon Brown, on the state of monetary conditions. This is the first time a letter as been triggered after ten years and 12o Monetary Policy Committee meetings.

Interestingly, a surge in inflation which is usually considered bad for a currency is the driver for the appreciation of the pound. This seemingly counter-intuitive behavior is related to market uncertainty. The inflation increase may be considered temporary. The market’s expectation is that there will be an almost certain policy response to bring the inflation rate back in-line at the 2% level. “As the remit for the Monetary Policy Committee makes clear, the thresholds for writing an open letter do not define a target range. The target is 2% at all times and is not a range.” How long the current rise in inflation will last is uncertain, but the policy response is considered clearer. The statement from the Bank of England must go out http://www.bankofengland.co.uk/monetarypolicy/pdf/cpiletter070417.pdf

The expectation is that interest rates will be increased as early as May to stem the rising inflation. While no action was explicitly stated, the expected rise in short rates to stem inflation which will make sterling more attractive on a carry basis.