STERLING ON THE RETREAT

UK growth worries increase as hopes of higher interest rates fade. Loonie keeps pace with the US dollar.

Sterling began the week looking good, rising by a cent and a half. The rot set in on Tuesday and it spent the rest of the week in retreat. By the time London opened this morning it nothing to show for its efforts but a three-cent loss.

It was Tuesday's consumer price index (CPI) data that market the turning point for sterling. Up to that point there had been a lingering hope that the Monetary Policy Committee would eventually decide that it must do something about Britain's high inflation rate, especially if it turned out to be as high as the 4.2% analysts were predicting. In the run-up to the CPI announcement many investors took precautionary long positions, buying sterling in the speculation that the figure might be even higher. They turned out to be correct in their supposition but wrong in their assumption that sterling would go up.

CPI rose by 4.4% in the year to February and the pound went down. Initially it fell as those long positions were sold off. The suspicion grew that Bank of England governor Mervyn King would continue to shepherd his MPC along the path of policy relaxation however high the rate of inflation. A day later, the minutes of the March meeting showed that there were indeed still only three members of the committee in favour of an interest rate increase.

Hours after the minutes were published the chancellor of the exchequer delivered his 2011 Budget speech. In it he gave tacit approval to the MPC's stance, saying that inflation of up to 5% this year would fade to 2.5% next year and 2% thereafter. He confirmed that the inflation target remains at 2% but gave no impression that the MPC was under any pressure to achieve it. Also in the speech he delivered the widely-anticipated downgrade to estimates of economic growth; 1.7% for this year, rising to 2.5%, 2.9% and 2.8% in the following three years. Friday's retail sales figures for February rammed home that new reality. After a tolerably successful January Sales season turnover in February was down by -0.8%. It was not a figure calculated to do sterling any favours.

With the economic impact of the Japanese earthquake becoming clearer investors felt less need to pursue a strategy of safety. They moved out of the haven currencies (actually there is only really one haven as long as G7 central banks are sitting on the yen, and that is the Swiss franc) and they moved back into the commodity-oriented and higher yielding "risky" currencies. Unfortunately for the Canadian dollar, it did not share the good fortune of its Australian and New Zealand cousins, both of which advanced by about 4% against sterling. Instead, it remained bound to its US uncle, rising by a mere 1.5%.

Inertia aside, the main reason for that lack of performance was the lack of any helpful Canadian economic data. The only figures of any consequence were for retail sales and they were unimpressive. Sales in January were unchanged on the month and -0.3% lower than a year earlier. It did not help matters when the Wall Street Journal published a piece drawing attention to the fact that Canada is no longer the biggest source of US imports; China has taken the top slot, having been in eighth position in 1990.

A reminder of Britain's struggling economy will come on Tuesday with the revision to fourth quarter GDP growth, previously estimated at -0.6%. House price indices from Nationwide and the Halifax are pencilled in for the end of the week and are unlikely to deliver any positive surprises. Canadian data are more plentiful this week but that is not saying much. There are the raw material and industrial product prices and January's gross domestic product.

Sterling is following a roughly horizontal path against the Loonie that looks increasingly messy. Another half cent of downside could open the way to a further two cents of losses. Buyers of the Canadian dollar should continue to hedge their risk, fixing a price for half the money they need with a forward purchase.

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