LONDON (Reuters) - Sterling recovered on Tuesday around a third of its losses since last week’s electoral shock, helped by above-forecast inflation which underlined the risks of the Bank of England tolerating a weakening currency in order to stimulate the economy.
The jump in inflation to its highest in nearly four years in May tightened the squeeze on consumers facing the added worry of political uncertainty after an inconclusive parliamentary election and with Brexit talks set to start.
It also added 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 of weakening the pound and fuelling inflation.
Sterling traded near the $1.27 mark for most of morning trade in London.
It rose further after the BBC reported that Britain’s ruling Conservative Party was likely to sign a deal on Wednesday to form a minority government after losing its parliamentary majority in last week’s election.
The pound last traded up 0.7 percent at $1.2753 and 87.82 pence per euro.
“We did see a bit of an uptick on the back of the inflation numbers, but I still think economic data has taken a back seat to the political situation in terms of driving the pound at present,” said David Cheetham, chief markets analyst at retail broker XTB.
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 focused on reducing a ballooning budget gap by cutting spending rather than raising taxes.
That again may bode better for economic growth ahead, while further complicating the Bank of England’s position.
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. 0#FSS:
“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.”
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 and Gareth Jones