The British pound (Exchange:GBP=) had a sterling performance over the past year, but could it lose some of its shine following the Bank of England's (BoE) inflation report?
Investors will be listening to BoE Governor Mark Carney closely today for any indications of an interest rate hike this year against a backdrop of a strengthening British economy. Jobs data for April, also due today, could drive sterling's performance too.
"For the next 24 hours, everyone's focus will shift to the British pound because the Bank of England's Quarterly Inflation Report is the most important event risk this week," said Kathy Lien, managing director at BK Asset Management.
"The big question before us is whether the economic landscape has changed enough for the central bank to take a more active approach to monetary policy and we think the risk is for a disappointment," she added.
After years of sluggish growth following the 2008 financial crisis, the U.K. economy has finally come back into its own and is set to clock up a healthy 3 percent growth rate this year. However, house prices remain a concern, with a 10 percent surge over the past year stoking fears of a bubble.
As the economy recovers, many industry watchers have speculated that the central bank could raise interest rates from all-time lows of 0.5 percent in a bid to offset inflation. Consequently the pound jumped 13 percent since last July, and is currently around $1.6833.
But Lien pointed out that while manufacturing and service sector data in the U.K. is accelerating, retail sales growth remains weak. More importantly, annualized consumer price growth slowed to 1.6 percent in March from 1.7 percent in February, dampening rate hike expectations.
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"The strong currency also puts further pressure on inflation and as long as the risk of a jump in inflation expectations is low, the BoE may prefer to keep monetary policy steady for the time being," added Lien.
She said the BoE could move to tame housing market inflation by scaling back its Help-to-Buy scheme and imposing mortgage restrictions, rather than tightening monetary policy.
But other analysts were more convinced that the BoE inflation report could give the pound a boost.
BNP Paribas said in a note they weren't expecting Governor Carney to push significantly against rising policy tightening expectations at today's press conference, leaving scope for rates to increase.
Furthermore, the bank also expects April jobs data to show another 35,000 decrease in jobless claims and a further decline in the unemployment rate to 6.8 percent from 6.9 percent in March, in line with consensus. And a stronger economy means higher expectations of interest rate hikes.
"With sterling already lagging the recent rise in U.K. short-term rates, we believe the case for building sterling longs has become more compelling," said Daniel Katzive, FX strategist at BNP Paribas, who said the bank's currency trading desk had initiated a short euro-sterling (Exchange:EURGBP=) trade recommendation on Wednesday.
Sean Callow, currency strategist at Westpac bank (ASX:WBC-AU), also told CNBC he believes the BoE inflation report could give the pound a boost on Wednesday despite his view that the bank won't hike rates for another year.
"The pound is due a little bounce, it's lost a bit of ground recently and I see it heading back towards $1.69, especially if the unemployment numbers come in strongly," he said.
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Callow doesn't expect any major policy changes to come out of the BoE's inflation report, however, and said Carney would likely retain an optimistic outlook on the U.K. recovery while acknowledging spare capacity in the economy.
"While the next move is almost certainly tighter, the spare capacity and the low inflation readings buy them plenty of time," he added.
BK Asset Management's Lien also pointed out that the pound has historically reacted strongly to the BoE's inflation reports, such as in February, whenpound-dollar (Exchange:GBP=) jumped more than 150 pips in one day after the BoE surprised the market by upgrading their growth forecasts and dropping their 7 percent unemployment rate threshold.
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