Sterling takes BoE in its stride, higher rate talk aids - Reuters UK

Thu Feb 10, 2011 3:32pm GMT

* Sterling rebounds from session lows on rate outlook

* Markets pricing in 85 pct chance of May hike

* Support for sterling at $1.6014, inflation report awaited

(Adds quote, updates prices)

By Anirban Nag

LONDON, Feb 10 (Reuters) - Sterling recovered on Thursday from a session low against the dollar hit after the Bank of England kept interest rates on hold, on strong expectations that high inflation will force a policy tightening by mid-year.

Traders said speculators liquidated some long positions they had built in the last few weeks but sterling found solid support, with central banks and leveraged accounts cited as buyers at lower levels.

Sterling GBP=D4 was at $1.6052, having fallen to a session low of $1.6011 soon after the BoE announcement. Chartists say there is support at $1.6014, which is the 50 percent retracement of its move from a low of $1.5750 on Jan. 25 to its recent three-month high of $1.6279 on Feb. 3.

The BoE had been widely expected to keep rates at 0.5 percent, but markets had priced in a 20 percent chance of a rate rise. Traders said the hawks who were expecting that had cut their positions, leading to a brief dip in sterling.

"The money markets were pricing in a 20 percent chance of a hike, but no one really expected the BoE to go," said Chris Turner, head of FX strategy at ING.

"The inflation report from the BoE is due next Wednesday and we expect them to be pretty hawkish there. So sterling will be supported by expectations of interest rate hikes. We see it at $1.70 by the end of the summer."

A rate hike is being largely priced in for May, while implied rates based on swaps rates show there is a nearly 22 percent chance of a rate hike in March. BOEWATCH

Speculation of a near-term rate hike has gained momentum on expectations that annual inflation will pick up, having already hit an eight-month high of 3.7 percent in December, almost twice the central bank's target.

RBC Capital said in a note that next week's inflation report may show more upside risk to inflation in the medium term compared to November, and that will give the market a clue as to when the BoE will raise rates and how aggressive it will be.

BOE DILEMMA

Minutes of the BOE's recent policy meetings have recorded a more hawkish tone, with two members voting for a rate hike last month. The minutes showed Martin Weale had joined Andrew Sentance in voting for rates to be raised, giving sterling bulls a huge boost.