Inflation fears prompt GBP decline

Markets can sometimes be considered as irrational beasts; defying logic and making it almost impossible to predict, with any degree of certainty, even the most obvious of price movements. The fact that this is an underlying and omnipresent feature prevents the majority of currency traders making any money. So much so that contrarian theory would almost suggest trading in the opposite direction to what you believe is certainly going to happen in order to have any degree of success. Fear not, however, for the humble fundamental announcements which are set in economic stone can be traded effectively with the use of the most basic logic. Today was a prime example, with the release of the bank of England minutes explaining not only the reasons why interest rates remained static at the last decision but also showing the level of support within the bank for the next controversial wave of quantitive easing through asset purchasing.

Investors fear of inflation are entirely rational. They are what influence the value of the currency by weakening the purchasing power when inflation is high and strengthening this when it is low. The correlation between inflation and unemployment is one of the most famous and simplistic economic models that exist. Simply, one has to be higher for the other to be lower. The release today of the Bank of England minutes showing, for the first time in seventeen months, a unanimous decision on the rate decision to remain at 0.5% was almost entirely expected. Slow growth across the entire Eurozone is forcing monetary policy to try to increase the flow of cheaper capital through lower borrowing costs.  However, the unanimity of the higher-than-expected next round of quantitive easing put investors into a spin and sent the value of the GBP falling.


Logical fears that, not only is the rate of interest on GBP unlikely to rise in the foreseeable future, but that the injection of liquidity could give rise to future inflationary problems. Moreover, the conviction of all members of the Monetary Policy Committee that this is the best way forward worries many investors who see this as a short-term fix to reduce unemployment figures. The fact that the UK has already settled on the idea that inflation will rise dramatically before falling back next year has been partly confirmed with the consumer price inflation rate hitting 5.2% on Tuesday. The combination of high inflation, low gowth, quantitive easing and minimal expectations for rate rises anytime soon has contributed to the entirely logical decrease of the GBP against the USD this afternoon.

The GBP therefore fell from its highs as expected today on this fundamental information. Investors see no immediate value in sterling and the threat of inflation without interest rate intervention makes it look decidedly weak. Today’s chart shows a fall from a resistance area which has been causing the GBP some difficulty over the past few days. The release of the meeting minutes has done very little to instil any confidence that it will be able to push beyond this level, however, markets can be highly irrational and this news may already be factored into the price.