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The UK CPI annual rate of inflation came out last Tuesday and rose to 4.5% in April following the temporary drop to 4% seen in March.

Mervyns’ letter to Osborne, explaining why the inflation rate was above the bank’s target of 2% will undoubtedly cite a jump in transport costs as the major contributor, in particular air and sea fares but the belief is that these pressures will fall off through the rest of the year.

Sterling picked up on the back of the news but the inflation reading is unlikely to change the BoE’s position on policy. The inflation blame game still points to external factors such as rising oil and food costs as well as the recent increase in VAT.

This was reflected in the MPC’s meeting minutes on Wednesday. The BoE decision to maintain interest rates at the current 0.5% was approved by 6 votes against 3, with Weale and Dale voting for a 0.25% rate hike, and traditional hawk Andrew Sentance in favour of a 50 basis point rate hike.

MPC members also discussed the possibility of inflation exceeding 5% later the year and slowing growth in Q2, considering such events as the Japanese earthquake. They agreed however that the overall pace of recovery should pick up.

Furthermore, UK unemployment fell by 77,000 in the three months to March, the largest decline since the second quarter of 2010. The Unemployment level fell to 7.7%, from 7.8%.

The hottest April on record and a Royal Wedding boosted retail sales and the figure came in above expectations. The strong figures strengthen hopes that the economy has continued to grow in the second quarter of the year. However, most analysts said the release should be treated with caution and that favourable circumstances were the reason behind the upturn.

Key releases for Sterling this week

Public Sector Net Borrowing – Tuesday at 8.30am

Growth Domestic Product is out on Wednesday at 8.30am – we believe the expected figure will be revised upwards as the measures take into account surveys from later in the quarter; ones that were not affected by the earlier snow.

Consumer confidence at midnight on Thursday.

Nationwide house prices are out on Friday morning at 6am – we believe this release will be bearish for sterling.

Jeremy’s trade of the week

This week’s trade of the week is a Leveraged Convertible forward with the client wanting to protect a 6 month budget over the coming spring period. He buys euros and sells sterling and wanted to take advantage of the recent weakening of the euro.

The client was able to achieve a worst case rate of 1.1400 on his option which allows the client to benefit all the way up to a rate of 1.2250 Should the rate touch the barrier level during the window period (1 month before the expiry date) then that month’s structure reverts to a forward at 1.14 in 2 times the amount needed. i.e. if you originally hedged a monthly exposure of EUR100k then you would need to buy EUR200k. If the barrier is not touched then he can of course trade in the spot market.

This strategy requires no premium, and the use of leverage allowed the client to increase both his level of protection and the barriers that he can benefit up to.  As there is a potential further strengthening for sterling in the future the structure allows for a large amount of beneficial movement whilst always protecting against adverse moves.

Have a great week.