October 18, 2016 / 8:15 AM / a year ago

Sterling bounces as eyes shift to inflation

* Graphic: sterling and gilt yields bit.ly/2dgAXn1

* Graphic: sterling year-to-date tmsnrt.rs/2egbfVh

By Patrick Graham

LONDON, Oct 18 (Reuters) - Sterling climbed back above $1.22 on Tuesday, benefiting from a cooling of the politically led selling that has hammered the pound since the start of October, and was aided by a broader pause in the dollar’s rally.

The pound was also 0.4 percent higher against the euro, and the UK currency has now held in a tight two-cent range for a week against both currency pairs.

Attention on Tuesday will be focused on inflation and any sign of a rise in import prices that might give the Bank of England pause for thought as it contemplates a further easing of monetary policy that might weaken sterling further.

But more broadly there is a sense that, in the absence of sharper moves in the dollar, it will take some concrete sign of economic weakness due to the prospect of a Brexit from the European Union to weaken the pound further in the near term.

“I think sterling is very exposed, but it is also going to need a trigger for it to go lower,” said Richard Cochinos, a strategist with Citi in London.

By 0810 GMT, the pound traded at $1.2240, up 0.4 percent on the day.

Sterling’s near-20 percent plunge since the June 23 vote to leave the European Union has sent inflation expectations soaring, driving investors to wind back bets on further interest rate cuts and other Bank of England stimulus measures this year.

But more broadly there are fears that continued rises in inflation will drive more sales of government bonds and weaqken consumer demand, threatening to push the economy towards stagflation as it faces the fallout of Brexit.

“We think higher inflation is negative news for the pound -the opposite to the typical impact of positive inflation surprises on G10 currencies recently,” RBC analyst Adam Cole said in a morning note.

“With the BoE likely to look through a transitory acceleration in inflation, the main effect will be to squeeze households’ real income as prices rise more quickly than wages, crimping consumer spending.”

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