Sterling swings on twin hazards
Associate City Editor STERLING swung wildly yesterday as investors fretted over the twin threat of higher interest rates and a fresh bout of deflation.
Official figures published today are expected to show inflation remained subdued last month having fallen back to zero in June.
It is thought that inflation could even slip back into negative territory – leaving Britain in deflation and easing pressure on the Bank of England to raise interest rates for the first time since 2007.
But Kristen Forbes, a senior official at the central bank, said waiting too long to increase borrowing costs ‘ would r i sk undermining t he recovery’.
The American economist, a member of the rate- setting monetary policy committee on Threadneedle Street, said ‘rates will need to be increased well before inflation hits our 2pc target’.
The comments pushed the pound sharply higher against the euro – up to €1.4154.
But sterling fell back later in the day, to as low as €1.4058, as investors grappled with the outlook for interest rates at a time of strong economic growth and ul t r a- l ow inflation.
Central banks traditionally raise interest rates to curb rising inflation. The prospect of higher rates tends to boost a currency as it attracts investors in search of better returns.
Joshua Mahony, a market analyst at City trading firm IG, the Bank faces a ‘clear dilemma’.
He added: ‘Ultimately what Forbes highlights is that there could be a time when a rate hike is desired in the face of low or negative inflation.’
With rates in the UK set to rise well before rates in the eurozone, Jane Foley, senior currency strategist at Rabobank, said the pound could hit €1.47 in the next nine months.
Cheaper food and oil and the strong pound, which has driven down import costs, have kept a lid on prices in recent months.
Oil slipped below $49 a barrel in London yesterday – down from £115 a barrel last summer. In the US, crude slumped to a six-and-a-half year low.
Low inflation at a time of rising wages has left families across Britain feeling richer.
Millions of households have also benefited from cheap mortgages since interest rates hit an all-time low of 0.5pc in March 2009.
Forbes compared the Bank’s job of taming inflation, through higher interest rates, to preventing sunburn.
‘With both sunshine and inflation, there is a peril to living only in the moment,’ she said. ‘One should plan for the future – especially if precautionary actions take time to be effective.’
She conceded that today’s figures from the Office for National Statistics are ‘likely to confirm that inflation has continued to hover around zero’.
‘With such low inflation, it is understandable to want to avoid pre-emptively ending this holiday,’ she said. ‘A solid recovery is finally here. Increasing interest rates prematurely could moderate companies’ willing- ness to invest and consumers’ willingness to spend.’ But warning that low inflation can ‘burn off quickly’, she said: ‘Maintaining interest rates at the current low levels during an expansion risks creating distortions.
‘Therefore, interest rates will need to be increased well before inflation hits our 2pc target. Waiting too long would risk undermining the recovery – especially if interest rates then need to be increased faster than the gradual path which we expect.’