Morning Currency Wrap for Wednesday February 16, 2011

Sterling Gets Smacked With Stagflation On UK's Horizon - The GBP, which has been the best-performing currency so far this year due to growing speculation that the Bank of England would raise interest rates to fight inflationary pressure in the UK economy, was knocked down after the BOE dampened hawkish interest rate expectations. The BOE pared back its 2011 growth outlook that it had issued in November and raised its inflation outlook, which in my book spells stagflation. In fact, the BOE said that inflation will quicken from a two-year high and peak at about 4.4% before easing to its 2% target by the middle of 2012. Thus, the BOE may need to keep borrowing costs at a record low to aid a recovery that is “unlikely to be smooth.” Elsewhere, the CHF was down after the Swiss government announced steps to deal with a strong currency by providing support to exporters. I think the market misunderstood the Swiss government because all it did was announce measures to help businesses cope with the strong CHF not measures to curb CHF strength, so this is a buy the dip moment. In fact, the Swiss government said that any monetary steps were the responsibility of the Swiss National Bank and SNB Vice-President Philipp Hildebrand  hinted that CHF strength would help to restrain inflation. Meanwhile, the Euro remained in a tight trading range against the USD and will probably remain that way until we get closer to the Irish election, where opposition parties have been making noise about renegotiating the EU/IMF bailout terms. In Asia, the Yen continued its decline as the risk trade continues as global recovery is gaining momentum. In Canada, the CAD was little change and remained in a tight trading range despite a disappointing read on the manufacturing sector. Statistics Canada reported that manufacturing sales were up by 0.4% in December, far less than the expected rise of 2.1 %. The market is waiting to take its cue from Friday’s core inflation data which will shed light on any future Bank of Canada interest rate movement.