The pound has lowered to a one week low versus the dollar today amidst further evidence that the Bank of England are to keep interest rates low. The signs of 'softening' confidence in the economy is leading the central bank to lower its forecasts for next year to 2.5 pct from 3.4 pct in May.
The likelihood therefore that interest rates will remain low are almost certain as Governor Mervyn King announced that the policy of the bank remains to 'wait and see':
"The Committee's central view remains that, once the effects of the price-level shocks –including the forthcoming increase in VAT – drop out of the twelve-month comparison, inflation will fall back, probably to below the target, reflecting the influence of spare capacity in the economy." he said today after high inflation prospects rose and were likely to stay above target for most of 2011 and hence lead to interest rates staying the same.
"The Bank of England's August Inflation Report (released on Wednesday) was rather more dovish than generally anticipated. Although the CPI inflation forecast (based on market rate expectations) was pushed higher over the next year or so - partly reflecting the planned rise in VAT - it was pushed down further ahead in response to a rather weaker outlook for GDP growth, itself partly reflecting the additional fiscal squeeze announced in the emergency Budget." added Vicky Redwood at Capital Economics, "As such, inflation is still expected to be well below the MPC's 2% target at the two-year horizon and beyond. Most strikingly, even the forecast based on unchanged interest rates and QE is also well below target in two years, implying that the Committee thinks that a policy loosening is more likely to be needed than a tightening."
This means that until the economy started to grow - and pressure inflation, then interest rate rises weren't likely.
By the same token, whilst VAT and other fiscal measures impacted, the GDP was likely to stay the same since interest rates could not be risen whilst there is risk of fiscal tightening sending the economy back into recession.
The Sterling tumbled as investors shunned the currency as a sign of weakening interest rates - meaning low growth prospects for the country, sent the British Pound weaker:
"The market seemed to be fixated for inflation to increase in the near term, which it did, but what is important is the forecast two years out," said Ian Stannard, senior currency strategist at BNP Paribas, "The market had not factored that in, so sterling is reacting accordingly."
The Dollar meanwhile was broadly stronger after the Fed said it would use cash from maturing mortgage bonds it holds to buy more government debt, a small step to counter weakening US economic recovery.