Last week was the first in eight that sterling fell on a broad trade-weighted basis, having appreciated over 3% over the past two months. You have to go back to June 2009 to find a similar stretch of weekly gains on the trade-weighted index. Naturally, given that the euro area is the main trading partner of the UK, a fair proportion of this can be put down to the weakness of the euro, EUR/GBP having moved higher in only one of these down-weeks on the sterling index.
There are a number of factors that have accounted for the strength in sterling, not least a belief that it has received some benefit from diversification away from the single currency itself. Related is the fact that it has not been as subject to the safe risk-flows as many other currencies. To put it another way, it’s neither the yen, nor is it the Aussie. It’s quite happily sat somewhere between the two when it comes to the ebb and flow of risk sentiment.
One of the near-term potential threats remains the inflation outlook. Although expectations are for the headline rate to continue to fall (from the 3.5% level reached in March), there has been a fairly consistent overshoot of inflation relative to expectations, particularly those of the central bank. As such, even though some of the growth numbers have disappointed of late, the simple belief that lower growth will lead to lower (than otherwise) inflation has been severely undermined in the UK in recent years. If we see more of this from the CPI data (Tuesday) and MPC minutes (Wednesday), the pound may struggle to benefit from a waning expectation of more QE and may worry more that the UK is facing a longer-term inflation problem.