ProgressiveFX.co.uk

Sterling is more than 3% lower against the dollar and over 2% lower against the euro. This reflects market reaction to the yesterday?s Bank of England Quarterly Inflation Report, and subsequent press conference. Much of the data for the Report was compiled before the MPC decision to reduce base rate by 1.5%. Consequently there was considerable focus on the Bank of England press conference. The Governor stated that current financial market conditions were ?unprecedented?. He laid emphasis on the rapid turn of events in September and October, citing three key factors behind the decision to reduce base rate by 1.5% on November 6th. These factors were: (1) very negative UK survey data (2) the exceptionally sharp fall in commodity prices (3) the collapse of Lehman and associated financial market events. The emphasis of the MPC is clearly on risks to growth. Short term, there is likely to be further downturn in sterling, which in the long run will place UK industry in a competitive position once the global economy recovers momentum.

Period rates have fallen significantly in response to the Quarterly Inflation Report and subsequent press conference comments. Forward markets virtually discount a fall in UK base rate to a low point of 2% by the spring of next year. The Governor placed emphasis on the 2% inflation target, emphasising that CPI would have fallen to 1% within the next 2 years had there not been a substantial reduction in base rate. The Governor indicated that further interest rate action would be taken if required. The current UK central bank forecast for growth is negative short term followed by a significant upturn in late 2009. If the economic climate continues to deteriorate, a fall in base rate to 1% is feasible. Our current view is that signs of recovery in the housing market will be apparent in the spring of next year and that base rate will reach a trough of 2%. The biggest risk to growth is the rise in unemployment. In September, the unemployment rate rose by 0.1% to 5.8%. It may well reach 7% by the spring of next year. Yesterday, 3 month LIBOR fixed at 4.3100%.

Equity markets remain in negative mode despite the prospect of further interest rate cuts and the probability that the global downturn will be far less pronounced than in the past. The impact of the credit crunch remains the key driving force, given the financial pressures facing some of the largest corporations, notably General Motors.

Brent crude (1 month forward) has fallen to $51/ barrel, on the negative prospects for European growth following the UK Inflation Report and a sharp downturn in German economic growth.