Inflation the Big Concern and Britain Leads the Way

With oil prices still hovering around $70/bbl (and with a realistic possibility of $80 oil), world prices are not likely to go down anything soon. Both headline and core inflation are on their way up, and that makes inflation more of a concern for central bankers than growth. What that means for forex traders is continuing hawkishness for monetary policy makers and a steady rise in interest rates all around the world.

The Bank of England led the way today, raising interest rates to 5.75%. The accompanying statement was not as hawkish as some currency analysts were expecting, however. The central bank made the claim that inflation was starting to get under control, with CPI nearing the 2% target level. And new Chancellor of the Exchequer Alistair Darling came out and said that the higher interest rates should prove a burden on new debtors in England, especially those with fixed rate mortgages. Trade union groups as well as the business lobby have protested the rate hikes, citing a possible brake on growth.

But housing prices in Great Britain are still as high as they have even been in years. The financial services industry in London is booming, carrying the economy to its largest growth in three years. M3 money supply in England is growing at a dangerous pace, and the Monetary Policy Committee members recognize the inflationary risk there. Taking into account the rapid growth of credit and broad money, the MPC left open the possibility of future rate hikes this year. In fact, most forex market analysts expect at least one more move upwards in the interest rate, bringing it to 6.00%.

In confirmation of that fact, December short-sterling futures went up to 6.33% shortly after the interest rate decision. The British economy has been resilient thus far to interest rate hikes, and the Great Britain pound should benefit. GBP/USD is up 3% this year and GBP/JPY is up 6%. Fundamentals point to the pound continuing to be a great buy and currency traders should continue to provide bid support for the sterling. Look for the cable to test 2.0500 in the coming days and weeks.