LONDON (Reuters) - Sterling strengthened on Tuesday after data showed British inflation unexpectedly stayed close to its highest levels in six years in January, firming up investors’ bets that the Bank of England will raise interest rates again in May.
The BoE surprised financial markets last week by indicating that rates could move up faster than previously expected, as the Bank wanted to bring inflation back to its target of two percent within two years rather than three.
This prompted markets to price in as much as a 70 percent chance of a quarter-point rise in interest rates by May, and a roughly 50 percent chance of a further increase in rates to one percent by the end of the year - a level last seen in 2009.
Tuesday’s numbers showed consumer price inflation (CPI) held at an annual rate of 3.0 percent in January, unchanged from the month before and above a consensus forecast of 2.9 percent.
Sterling jumped to as high as $1.3924 after the data, up from $1.3886 beforehand. It was trading at $1.3892 by 1650 GMT, up 0.4 percent on the day, having climbed more than six percent against the dollar over the past three months.
“We think the long-term uptrend remains intact,” wrote UBS Wealth Management strategists in a note to clients. “Our positive sterling view rests on three factors: less Brexit uncertainty, a hawkish Bank of England (BoE), and a solid global economy.”
“The downside limit should be around $1.34. Going lower would be equal to pricing out any BoE rate hikes, and to seeing the dollar getting back to its strong overvaluation of previous years. Both seem unlikely to us,” they continued.
The pound skidded to a three-week trough below $1.38 on Friday after the EU’s chief Brexit negotiator Michel Barnier warned a transition deal was far from assured.
Those comments, as well as broad strength in the dollar amid a sharp stock market sell-off, handed sterling its biggest weekly falls since October, as investors worried that Britain could leave the European Union in a disorderly manner.
Against a broadly stronger euro, sterling weakened 0.2 percent to 89.04 pence.
“Our long-held view of higher UK rates and sterling still stands, but in the short term the politics, stretched market positioning and the state of the global risk environment may provide headwinds against the pound,” said Nomura currency strategist Jordan Rochester.
Analysts said British wages data due next week, as well as a major upcoming speech by the prime minister on Brexit, would be the next determinants of sterling’s direction.
Reporting by Jemima Kelly, Kit Rees and William Schomberg; Editing by Tommy Wilkes, Andrew Heavens, William Maclean