Sterling recovered around a fifth of its losses since Thursday’s electoral shock on Tuesday, helped by high inflation numbers which underlined the dangers of the Bank of England tolerating a weakening currency in aid of stimulating the economy.
The jump in inflation to its highest in nearly four years in May tightens the squeeze on consumers now facing the added worry of political uncertainty after inconclusive parliamentary elections and the launch of Brexit talks.
But it also adds to pressure on the Bank of England, even if it does not raise interest rates over the next three years, to hold off with any more injections of cash into the economy for fear further weakness of the pound and higher inflation.
That all played into a steadier tone for sterling in London trading.
“This morning was all about profit-taking on the move since the election,” said a trader with one international bank in London.
“The inflation numbers, in the end, may have helped support that move, but it has been a marginal call. There are a lot of people out there talking about selling the pound again.”
By midday in London, sterling was up half a percent on the day against both the dollar and the euro.
At $1.2730 and 88.07 pence per euro it is still down around 2 percent since the release of exit polls on Thursday.
Inflation unexpectedly jumped to 2.9 percent – its highest level in nearly four years in May, muddying further an outlook that shows the UK economy slowing but prices rising much faster than the Bank of England’s 2 percent target.
Having drifted earlier this year towards expecting the Bank of England’s next move to be a rise in interest rates, short sterling contracts now show next to no chance of a hike in the next two years.“The fundamentals (for sterling) still are not positive, they are negative,” said Citi strategist Josh O’Byrne.
“But you have the fiscal angle or the BoE – I don’t think these are going to come into play soon. But if they do, it would slow sterling’s fall.”
Beyond inflation, the market has begun to discuss the implications of Thursday’s vote, which cost Prime Minister Theresa May her majority in parliament, for her Conservative Party’s push to cut back on public spending.
The Times reported on Tuesday that May has accepted that voters’ patience with austerity is at an end after seven years in which the government has focussed on reducing a ballooning budget gap by cutting spending rather than raising taxes.
That again, may bode better for growth going forward, while further complicating the Bank of England’s position.
The UK budget deficit was 2.5 percent of GDP in the 2016/17 financial year which ended in March, its smallest since before the global financial crisis. (Reporting by Patrick Graham and Ritvik Carvalho; Editing by Jon Boyle)