Long-term Sterling risks

Expectations over a further series of interest rate increases will offer short-term Sterling support, especially after a strong headline earnings report. Interest rate rises to this level, however, would strongly increase the risk of a hard landing for the UK economy, especially as the housing sector risks are already at an extreme level.  

Sterling pushed to 2.01 against the dollar in early European trading on Wednesday as markets looked to extend the recent gains with a further advance after robust UK data.

Following the higher than expected headline inflation rate of 3.1%, Bank of England Governor King still expressed confidence that the inflation rate fall would fall sharply later this year. The Bank of England voted 7-2 for unchanged interest rates in April with the dissenters calling for a rate increase given the strong upside inflation risks. The earnings data was stronger than expected with a headline jump to 4.6% from 4.2%, although the underlying figure was steady at 3.6% while unemployment fell by 9,200. Inflation fears will persist in the short term after the earnings data, but a slightly more sober judgement is likely to be taken over the next few days given the underlying figure.

The longer-term UK outlook will need to be watched closely as the inflation rise and pressure for higher interest rates will increase the longer-term risks of a hard landing for the UK economy with the risk that the housing sector will deteriorate sharply over the next few months.