UK Inflation and GBP Exchange Rates

This morning it has been confirmed that UK inflation has risend further to 2.9% nearly one percent over the Bank of England’s target. This figure is a 14 month high and shows just how much pressure is currently on the new governor of the Bank of England, Mark Carney who only started in his new postion at the start of this month. The rise in inflation has led to Sterling exchange rates falling this morning against most the major currencies, at the time of writting Sterling Euro exchange rates are down 0.3% and Sterling US Dollar exchange rates are down by 0.2%, while this does not sound a lot, a 0.3% move on £200,000 is €691 and this movement has happened in less than 20 minutes and it is possible that this movement will continue.

Should UK inflation breach 3% which is 1% more than the Bank of England target the governor of the Bank of England has to write an open letter to the Chancellor of the Exchequer explaining why inflation is running so high and what the central bank are doing to bring it back in line with their target. So, the fact that we have avoided this level is a small positive and has avoided some embarrasment for the new Bank of England governor.

The question now will be what will Mark Carney do to reduce rising inflation? Inflation is a measure of the increase or decrease of the price of goods and services and so theoretically a central bank would increas interest rates in order to encourage people to save money rather than spend it which as a result leads to retailers and manufacturers reducing the price of their goods and services in order to encourage people to spend money with them. The difficulty for Carney is that he has already stated that interest rates will need to remain low to help get the economy growing again. Should the central bank decide to increase interest rates we could see it damage the already fragile housing market and reduce the amount of money that banks are lending which is key to help more funds move through the system. So, if the central bank cannot increase interest rates to reduce inflation what is left for them? One could argue that by maintaining Quantitative Easing (QE) the addition of more money being pumped into the economy causees inflation to rise so the Bank of England could consider tapering down their QE programme although, again this is unlikely to happen. The current warm weather is likely to encourage more spending which could have a further knock on effect to inflation pushing it higher still.

So, it appears that inflation is likely to continue to push up, in fact in the coming months I would not be surprised to see Mark Carney have to write a letter to the Chancellor as inflation pushes past the 3% mark. As a result we could see the current QE programme questioned and any addition to QE could cause weakness for Sterling exchange rates and should inflation continue to rise we may well see Sterling struggle to push up against a number of the major currencies. The Bank of England may simply have to turn a blind eye to rising inflation as it continues to concentrate on helping the UK economy to grow. We just have to hope that we don’t see inflation get too far out of control.

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