Wednesday May 14, 11:26 AM
Forex - Pound dives as BoE warns of inflation hitting 4 percent UPDATE
(adds analyst comment on reduced chances of June rate cut)
LONDON (Thomson Financial) - The pound suffered hefty falls, dropping under the $1.93 mark for the first time since early March after the Bank of England warned that headline
inflation may swell to levels near 4 percent by autumn.
The central bank effectively put markets on warning for a period of stagflation -- when growth slows but inflation remains elevated -- as it also lowered its GDP growth projections substantially today.
Under normal circumstances, soaring inflation tends to boost a currency but given the current backdrop of rapidly slowing growth, markets are doing just the opposite.
Analysts believe the BoE's latest projections pretty much kills off the chances of a June interest rate reduction.
'We still think interest rates will eventually fall considerably further as the economy continues to weaken and inflation concerns finally fade. But a June cut now looks pretty unlikely and any further loosening will be modest in the foreseeable future - seriously bad news for the economy,' said Jonathan Loynes at Capital Economics said.
At 11.05 a.m. BST, the pound fell to $1.9398 from $1.9423 while the euro was up at 0.7948 pound from 0.7932.
In its quarterly Inflation Report, the central bank said its base case scenario is that the annual CPI (NYSE: CPY - news) inflation rate will likely hit 3.6 percent this autumn because of higher energy and import costs -- subject to interest rates moving as the markets currently expect.
However, its fan chart, which shows the range of forecast probabilities, suggests that there's a real chance it could rise to 4 percent or even higher, a marked pick-up from its own previous projections.
The BoE also warned that the UK economy is in danger of grinding to a halt this year, and possibly sinking into recession, as a result of the crisis in credit markets. It said there is a high risk that GDP growth could fall to an annualised rate of 1 percent by the end of this year, the lowest levels since the early 1990s recession, even though the weaker pound should boost exports.
The news follows on the heels of a dismal labour market report showing a third consecutive rise in jobless claims. Many see this as a sign that the labour market is starting to turn.
'There is a clearer sense that we are at the turning point,' RBS (LSE: RBS.L - news) analysts said.
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