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Published On: Wed, Aug 13th, 2014

Dovish BoE report puts the fragile correction of the pound to an end

The inflation report released on Wednesday showed central bankers expectations of subdued wage growth in the coming months; inflation forecasts were also slightly lowered.

The inflation report released on Wednesday showed central bankers expectations of subdued wage growth in the coming months; inflation forecasts were also slightly lowered

The release of the Bank of England inflation report lead to a massive selloff of the British pound. The GBP/USD touched 1.67, a level unwitnessed in more than two months, almost five figures away from the $1.7193 peak hit in July. The euro rallied against the cable to levels of 0.8018 as of 12:55 pm GMT.

The euro also sank lower against the dollar in the morning to test its support at 1.3340 after the figures for the industrial output of the euro zone surprised negatively. The yen also suffered to the strength of the US dollar after a report showed that the Japanese GDP had shrunk with 1.7 percent quarter on quarter.

The reason for the broad pound weakness was the dovishness of the BoE report pointing to subdued wage growth in the next months: the forecast was cut to 1.25 percent for 2014, compared to the previous value of 2.50 percent. Central bankers’ expectations are for a pickup in wage growth in 2015. It was added that labor payment developments will be decisive for the timing and pace of future rate hikes. Forecasts on inflation were also slightly changed to the downside.

The dovish tone of the inflation report in turn shifted investors’ expectations of the first rate hike for the beginning of 2015. It was previously believed that BoE could start tightening its monetary policy this year. The recent dovishness of policy makers combined with softer economic numbers coming out of the UK lead to the meltdown in GBP/USD.

As far as the EUR/GBP is regarded, most traders and analysts still prefer the short trade on the pair in spite of today’s strong bounce to the upside. The reasons for that include: the prevailing downtrend in the EUR/GBP; the expectations of a Bank of England rate hike next year due to the steadily improving UK economy; the Ukraine crisis posing much more threats to the EU compared to Great Britain; the fragile state of the euro zone economy; and last but not least, the easy policy outlook in front of the European Central Bank.

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