Sterling was one of the weakest performers on the majors last week, adding to the perception that it is starting to struggle to gain further momentum simply as a by-product of not being in the eurozone. Naturally, it’s been a stretch to label sterling a safe-haven currency, but there’s no doubt that is has benefitted from events in the eurozone, with the solid performance of the bond market reflecting this. This position has allowed it to bypass the debate about the performance of the domestic economy and also the impact of the government’s austerity program.
Rising above the underlying issues is getting harder though. Even though the 0.7% decline in output in the 2nd quarter was down to some one-off factors (most notably an extra day’s holiday), the government was far less inclined to blame it on events elsewhere, such as the eurozone crisis. For this week, the Bank of England will once again have its say with the publication of the latest Inflation Report. The usual train of events is for the Bank to downgrade its forecasts for the economy and revise inflation forecasts upwards as the level remains stubbornly high. The May report saw inflation for year-end revised up nearly 1% vs. the February projection. If anything, inflation has fallen below expectations, but the Bank is unlikely to instigate a large downward revision as some of the inflation fall was down to the early timing of sales and the outlook for food prices looks to be modestly bearish in light of poor harvests (those already seen and to come).
Perhaps the biggest point of interest for Wednesday will be the extent to which the Bank talks about other policy measures. In recent months, the minutes have shown a greater debate around the possibility of cutting rates, whilst the Bank remains keen to see some results from the recent Funding for Lending scheme. For now, the recent rise in EUR/GBP is likely to be sustained as the safe-haven story loses steam, but at present there does not appear to be anything for sterling bulls to replace it with.