European events continue to dominate the headlines as the debt crisis plaguing PIIGS countries such as Greece and Portugal remains the main worry for market participants. Although these highly indebted nations have managed to avoid a credit event, many are growing increasingly worried that a contagion is right around the corner, threatening to bring down a number of euro zone economies. In fact, yields on One Year Greek debt are now above 100% while French banks are preparing for a downgrade and German authorities are readying their financial system for a catastrophic default, suggesting that the worst is far from over in the currency bloc.Thanks to this focus on the PIIGS countries, the UK has managed to sneak by realtively unscathed. The nation had one of the higher budget deficits but was one of the first to implement austerity measures and as a result, is seeing weakness in its economy but a slightly improved budget situation going forward. Yet, the real issue facing Great Britain in the near term is not the pace of growth in the country, but rather the relatively high rate of inflation, which threatens to send the economy off the tracks. Some are increasingly concerned that the Bank of England may have to raise rates in the near term in order to combat this threat of rising prices, making today’s UK CPI report especially important for investors focused on investments in Great Britain [Pro Members can see the Ex-Europe ETFdb Portfolio here].
Later today, the CPI rate in the country is expected to accelerate to a year-over-year increase of 4.5%, up ten basis points from last month’s 4.4% reading. This continues the recent trend of increases in the CPI and could mark the 9th consecutive reading that is above 4.0% in year-0ver-year terms. In fact, British CPI has not been below 4.0% since January of this year suggesting that inflation is increasingly a problem in the economy and that the figure is well above the Bank of England’s comfort zone of 2% [see Non-Euro Europe ETF Options].
Even more troubling is the fact that the Bank of England expects inflation to top five percent at some point before finally decelerating later this year or early next. Inflation has been above the target for four straight years and could stay above the target for another two, suggesting that Britain may not exactly be committed to crushing inflation in the near term. “We have an underlying bearish view on the pound because of the economic backdrop,” said Beat Siegenthaler, currency strategist at UBS AG in Zurich. “The Bank of England is not exactly an inflation hawk.” While this focus on keeping monetary policy loose could help to boost growth, it also suggests that investors in pound-denominated assets may be on the losing end of the trade as the British currency continues to slide against many of its major counterparts, and especially so if inflation remains above a tolerable level [see all the currency ETFs here].
Thanks to this key report, investors should look for the CurrencyShares British Pound Sterling Trust (FXB) to be in focus throughout Tuesday’s trading session. The fund tracks the British pound by following the movements of the currency against the American dollar, rising when the pound strengthens against the greenback. So far in 2011, the fund has put up an average performance, gaining 1.2% since the start of the year. However, over the shorter term, FXB has declined, falling by nearly 2.9% in the past two weeks alone, suggesting that pressure is beginning to build on the British currency. Should inflation continue to come in above targets, investors could expierence more weakness in this Rydex product going forward. If, however, inflation finally comes in below expecations, it could signal to some to be more optimisitc on the British currency, boosting FXB in this week’s trading sessions [see more charts of FXB here].
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