Today’s Bank of England Quarterly Inflation Report has suggested that UK inflation has peaked and is likely to fall sharply from its current rate of 5% (down from 5.25% in the previous month September) to 1.3% over two years. The Bank has also cut its UK economic growth forecasts to 1% for 2011 & 2012 but indicated growth should climb towards 3.1% in two years.
Both the outlook to economic growth and inflation are seen as unusually uncertain and much will depend on developments in the Eurozone, the Eurozone debt crisis posing the single biggest risk to the UK economy.
Current forecasts suggest that UK interest rates are likely to remain low for a prolonged period of time with the first interest rate hike from the Bank of England not expected until at least 2013 whilst the prospect of further Quantitative Easing remains a strong possibility.
The debt crisis continues in Europe with Italian 10 year debt trading back above the unsustainable level of 7% and the yield of Spanish government bonds back above 6%. Besides the usual suspects, debt market yields of France, Austria, Netherlands and Belgium have also risen sharply, hitting Euro era highs. Moreover, the spread between French and German 10 year debt has also hit a fresh high.
Clearly the debt crisis poses a significant threat to the value of the Euro, the Euro has been surprisingly resilient so far but over the medium term I would expect the Euro to fall against the US Dollar and Sterling.
On the interbank market the Pound is currently trading between 1.57-1.58 against the US Dollar and between 1.16-1.17 against the Euro.
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