·         GBP/EUR moves close to 1.15 overnight

·         Inflation rises to 2.9% on petrol, VAT changes

·         German investor sentiment plummets on Greek fears

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News that inflation in the UK rose to 2.9% in the month of December saw the pound rise again yesterday.

Inflation is now only 0.2% away from the level where Mervyn King is compelled to write a ‘Dear Chancellor’ letter to explain why inflation is where it is. The reason for the swings are twofold: oil price movements from late 2008 falling out of the yearly figures and the 2.5% cut in VAT coming into them. We believe that inflation will continue to rise in the UK, and globally, and still believe that we will see an interest rate hike in Q3. One thing that has also been made more certain is that the vote to end QE in the UK has got a lot easier to justify.

Sterling spent most of the day above the 1.64 level against the US dollar whilst consolidating its position above the important technical level of 1.1340 against the euro. The pound was also helped by the news that a deal has been struck between British confectioner Cadbury’s and the US food conglomerate Kraft.

For all the good news the UK and sterling is currently receiving the euro is receiving an almighty dollop of woe. German ZEW investor sentiment fell to 47.2 yesterday as fears over the prospects for Greece and its economy weighed on hopes of a recovery. The Germans are especially wary of deals involving Greece as they are the most likely to have to foot the bill. News from ratings agencies were also poor for the single currency with one official from S&P commenting that if the new ‘austerity’ document being worked on by members of the ECB and the Greek central bank is in any way watered down then that could cause further ratings downgrades.

But there’s always a shadow on the horizon. I would be surprised if sterling does not have a fairly large retracement soon given the speed of its rise and other factors. The pound is naturally correlated with the banking and financial sector. So far their Q4 earnings have been rubbish (Citibank losing $7.3bn in ‘09) however while we have seen falls in the value of UK banking stock we have not seen a slide in the pound. Profit taking from long GBP positions will also be a factor.

The data from the UK keeps coming thick and fast with unemployment figures due at 09.30. Unemployment fell in December but we don’t see this trend continuing in January. US PPI is also due at 13.30.

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