Pound Climbs as BOE Reaffirms View Inflation Will Rise

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The pound climbed versus 14 of its 16 major peers after Bank of England officials said economic slack probably will be eroded in a year, signaling potential inflation pressures that will require monetary tightening.

Sterling halted a three-day decline against the dollar. Policy makers said inflation was likely to pick up “notably” toward the end of year as two officials said the decision to hold or raise rates remained “finely balanced,” according to minutes for the BOE’s May meeting. The Monetary Policy Committee had voted unanimously to keep interest rates at a record-low 0.5 percent this month. U.K. government bonds declined.

“The minutes are a little bit more on the hawkish side than the market was expecting,” said Alvin T. Tan, a foreign-exchange strategist at Societe Generale SA in London. Signs two members were close to voting for an increase as well as the fact that “the BOE continues to see inflation going to pick up, brushing off the idea that the U.K. will fall into deflation, has generally kept the pound on the bid side.”

The pound strengthened 0.8 percent to 71.34 pence per euro at 4:55 p.m. London time. Sterling rose 0.2 percent to $1.5545, after depreciating 1.7 percent in the previous three days.

The MPC said its best collective view was that the level of slack in the economy was about 0.5 percent of gross domestic product and “likely to be fully absorbed within a year.” Low inflation rates won’t last very long in the absence of further declines in energy prices or sharp movements in the exchange rate, the minutes said.

Investors are currently not fully pricing a 25 basis-point increase in interest rates until July 2016, according to MPC-dated forward Sonia fixings data provided by ICAP Plc. That assumes the current four basis-point spread for Sonia fixings below the official bank rate would return to zero once the central bank raises borrowing costs.

Zero Inflation

The U.K. currency tumbled on Tuesday against the dollar after data showed Britain’s inflation rate fell below zero last month for the first time in more than half a century.

Gilts declined with their European peers. The yield on benchmark 10-year gilts rose three basis points, or 0.03 percentage point, to 1.97 percent. The 5 percent bond due in March 2025 fell 0.265, or 2.65 pounds per 1,000-pound face amount, to 126.845.

Some policy members “will change their votes in the next couple of meetings,” said Daniela Russell, a U.K. rates strategist at Credit Suisse Group AG in London. “I suspect that the continued fall in the unemployment rate will cause them to be optimistic that we will soon see a faster pick-up in average wages. Given the central estimate of slack is just 0.5 percent, they’ll be keen to begin to tighten policy soon.”

(Corrects time stamp in fourth paragraph.)
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