Inflation pushes sterling into dip
Currencies: Politics takes toll of markets
Tuesday 10 October 1995
Worse-than-expected inflationary pressures in manufacturing took their toll on the markets yesterday, against a background of political worries generated by the defection of the Tory MP, Alan Howarth. Sterling fell, gilts dropped back and hopes of an early cut in interest rates receded.
At the London close, the trade-weighted index of sterling had fallen from 85.1 to 84.6. The pound ended the day at DM2.2413, 1.5 pfennigs down against the mark compared with Friday. However, against the dollar, the pound rose half a cent to close at $1.5867.
"Sterling is always vulnerable to politics," said Kit Juckes, currency strategist at NatWest Markets. "Following the defection of Mr Howarth, some people have been ... redoing the arithmetic on the timing of the next election, with an increased awareness it might come sooner than anticipated."
The City was also taken aback by the fact that the annual rate of inflation in fuels and materials purchased by industry rose from 9.2 to 9.5 per cent. The rise, the first since April, surprised the markets, which had been expecting a further decline to under 8 per cent. Meanwhile, factory- gate inflation, which had fallen in August to 4.4 per cent rose back again in September to 4.5 per cent.
The markets' reaction was to mark down the price of the December short sterling future, which indicates expectations of short-term interest rates. By the end of trading, the contract was implying interest rates of 6.71 per cent, a rise of 10 basis points, taking it close to the existing base rate of 6.75 per cent. As recently as Thursday, the markets were anticipating a cut in rates to 6.54 per cent. The December gilt future also lost more than half a point.
"There was no scope in these figures for an early cut in interest rates," said John Shepperd, chief economist at Yamaichi International. "They were poor, particularly on the input side, where they were considerably worse than expected. The key question is how far this pressure will be passed down the chain. The longer it persists the higher the risk of some ultimate impact on retail prices."
The monthly increase in input prices in September was a seasonally adjusted 0.9 per cent, much higher than the 0.2 per cent expected by the City. Back revisions to the data made the release still more disappointing. The monthly increase in input prices was raised from 0.5 to 0.8 per cent for June and from 0.1 per cent to 0.5 per cent in August, taking the annual rate in August up to 9.2 per cent rather than the 8.9 per cent previously registered.
The increase in prices was not across the board but concentrated in home-produced manufacturing inputs, particularly animals for slaughter, and crude oil. The exceptional summermay have played a role in the unexpected rise.
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