We are in the final week of British Winter and are about to turn the clocks forward to get ready for the blossoming of spring.  We are all looking forward to the longer, lighter nights and the promise of summer.  In keeping with new beginnings, last week the CPI released their revised basket of goods and services for 2010.  It will be used for the first time to measure February’s inflation figure and the data prints tomorrow, 23 March 2010.

The new basket includes some interesting additions and omissions reflecting the changing needs of the British public.  Hairdryers are out and straighteners are in, dvd players out and Blu-Ray players in while fizzy pop has been replaced by small bottles of water.  The prices of these will be monitored for the next 12 months and their fluctuations used to devise CPI and RPI.  RPI is the inflation figure that is commonly used in pay negotiations.

In fact, over the course of the coming months many expect inflation to rise sharply above the Bank of England’s threshold of 3% (2% +/- 1% is their stipulated target), the rate above which Governor King must write a letter to the Chancellor to explain why this is the case.  The reasons are not too complicated, the purchase of £175bn worth of gilts issued and then purchased back by the BoE is without doubt one of the most influential factors causing this increased inflation.  This increased inflation gives rise to calls for increasing interest rates.  It seems a likely bet that sometime in the next 12 months the BoE will raise the base rate from the historic lows of 0.5%, where they have been held for the past 12 months. This will have a significant effect on sterling, fundamental economics stating that higher interest rates lead to a stronger currency.

And like the cyclical nature of the transition from season to season, this brings us back nicely to the authors’ favourite topic of cogitation when writing the weekly update, sterling.  The question marks that have loomed large over sterling most recently have been the scale of the deficit and the concerns over a hung Parliament.  Even the fantastically impressive and unexpected jobless numbers that came out last week couldn’t provide the catalyst to move sterling through resistance at 1.13 against the single currency and we subsequently fell back.
This Wednesday Alistair Darling delivers the most important budget of the modern era. Primarily, it is his responsibility to assure markets that the Government is capable of ensuring fiscal security and reducing the deficit. Secondarily, it is a fantastic opportunity to persuade or dissuade voters to put their cross in the Labour box come May or end their 13 year period of Governing the House.  Usually a budget has very little effect instantaneously on the market but certainly Alistair Darling will be the cause of a lot of head scratching for FX strategists as they try to map out the course of sterling over the coming months.

Expect the usual tax bulls-eyes of cigarettes and alcohol to be a well ploughed furrow and I think we are all bracing ourselves in preparation of paying more tax.  Dependant on the public sentiment the Budget could win or lose an election.  It will certainly fill in a piece of the puzzle and after many months of fence sitting it looks as though analysts will finally have enough clues to put their necks on the line and start answering questions like ‘is the road map back to financial stability acceptable?’ and ‘what are the chances of a hung Parliament?’.  May’s election isn’t too far away, and after Wednesday it will seem even closer.

Trade of the week

This week’s trade of the week is the simplest option available and therefore the hedge that gives the client the most freedom possible. The ‘Vanilla’ is the building block of the options world and is one of the most popular trades in the market at the moment.

The buyer of this trade is an exporter based in the UK who is selling products in the US. He wanted to protect a GBPUSD rate of 1.52 for the next 3 months. The client believes that USD will gain against the pound over the course of 2010 but must at least get a level of 1.52 to keep his margins unaffected. This cost the client only 1.75% of the notional amount (the amount hedged). For that he receives 100% protection at 1.52 and every piece of upside forthcoming i.e. should GBPUSD be trading at 1.40 on expiry the client would receive 1.40.

This offers the client the most amount of freedom to benefit in possible upside while still being protecting a rate that benefits his business. This works on all currency pairs and is available to both buyers and sellers of sterling.

Have a good week