For the U.K., rising inflation is just like that cowlick you can never seem to tame. You can pat it down all you want, apply hair gel and all sorts of hair products, but it still won't go down! Just last November, the prices of goods and services ticked up again, recording an increase in inflation from 3.2% to 3.3%, still well above the BOE's target of 2.0%. But this isn't something new. Inflation hasn't fallen below 3.0% in 11 straight months!
As for the rest of the economy, the U.K. has been receiving mixed feedback. On one hand, factory growth jumped to a 16-year high last month. In contrast, construction activity, the housing market, and services industry have all posted dismal marks lately.
Economic gurus have bet their two cents that BOE Governor Mervyn King will announce that the central bank will continue to maintain the size of its bond holdings at 200 billion GBP, while keeping the base interest rate at its current level. In fact, I share their common belief that we probably won't see the BOE start withdrawing its stimulus until the fourth quarter of the year.
With inflation already at 3.3%, you might say that that's bollocks! However, we also have to take into consideration the negative effects on growth of the toughest set of austerity measures that the U.K. has seen since World War II.
The British Chambers of Commerce (NYSE:BCC) estimates that growth from October to December 2010 slowed to around 0.4%-0.5% following the 0.7% uptick we saw in the third quarter. And with the value-added tax hike from 17.5% to 20.0% about to be implemented, the economy may still need stimulus to get output and consumption going.
There's also the clash of the doves and the lone hawk that we have to watch out for. Adam Posen, one of the most dovish members of the MPC, believes that inflation will eventually ease. Analysts expect Andrew Sentance to counter this view and ask for a rate hike once again. The big question is, has he convinced his other chaps to shed their dovish feathers for hawkish ones?
So, it'll be interesting to hear what tone the BOE statement takes. If we receive any surprise comments, we could be in for a doozy. And we all know what surprises in the forex market normally mean: volatility!
Despite the boost that the pound got from the U.K - China business deals earlier this week, GBP/USD stayed within the tight range which it has formed in the wake of the new year. Moreover, during the past few months, the pair seems to have formed a wedge formation. Is a breakout imminent?
Remember that the tighter the consolidation, the bigger the move usually is after the breakout. If the BOE remains steadfast in its commitment to keep rates low, we could see the pair break down and start heading towards its 2010 lows around 1.4300. On the other hand, if someone were to join Mr. Sentance and dissent, it could cause havoc in the markets and push Cable all the way back up to the 1.6000 handle.
While we may not see any developments overnight, I'm going to be keeping an eye on any progress with each passing MPC statement. Remember, even the biggest events can be caused with the smallest spark. For all we know, tomorrow's rate statement could set the tone for the rest of the year.