Lagarde Asks For UK Easing As Papademos Argues That Grexit Risk Is Real

We knew yesterday that a vast proportion of the coverage in markets would be around the state of the UK economy and the sterling weakness which we also expected has materialised.

Inflation in the UK came down to the 3% level for the first time in nearly two years as falls in oil prices (down 14% from the highs in mid-March) and the increase in sterling (up 6% in the past few months) have helped consumer baskets. The impact of these factors may dwindle over the course of the summer so further falls in inflation cannot be counted upon.

The wiggle room now exists for further quantitative easing in the UK, or at least what the IMF thinks. Christine Lagarde, in a joint press conference with the Chancellor, said that the Bank of England may need to look at further monetary policy easing via further asset purchases or interest rate cuts. I think we may see the Bank agree to this at their June meeting and pump around £50bn into the market over the course of the following 3 months. The amount does depend on the prospects for Greece however, a disorderly exit could see a much greater amount of easing.

Unfortunately for mortgage payers, I think an interest rate cut is not going to happen. The marginal benefit of a 25bps cut would be very little as consumers still remain reticent to spend and spare cash would be likely to be used for savings or the paying down of debt, none of which stimulates the economy.

The IMF also commented on the fiscal plans of the coalition government. Lagarde was at her theatrical best by saying she “shudders” to think what the UK debt picture would look like had the deficit reduction plan not been implemented. She did call for a “Plan B” however, a progression to looser fiscal austerity should growth not be forthcoming. PMQs today will make for interesting watching today as a result.

Overall, sterling has slipped against the resurgent US dollar following some comments from former Greek PM Lucas Papademos who said the risk of Greece leaving the euro is real. EURUSD came back into the mid-1.26s while GBPEUR eased back above the 1.24 level. Papademos later said that no specific preparations were being made by European institutions for a Greek exit but he cannot “exclude the possibility”.

This followed a day of further butted heads between France and the rest of the core European countries on the discussion of Eurobonds. The Austrian Finance minister charmingly dismissed Francois Hollande’s plans as “nonsense”. At an auction of 2 year debt today Germany believes that it will get enough demand for the bonds even if it pays no interest at all; that demand for German assets will outweigh the demand for a return. Such is the dislocation in European markets and hence why the core is unwilling to underwrite the periphery and no longer benefit from lower yields.

The limelight will remain on the UK today with UK retail sales and the minutes of the latest Bank of England meeting to both be published at 09.30. Retail sales are forecast to slip as a result of the poor weather and a post-mini fuel crisis dip. The minutes are likely to show that only one member of the committee voted for further QE following Adam Posen’s very public vacillations.

All in all we expect today to be once again a negative day for sterling with a possible break into the 1.56s against the US dollar.

Latest exchange rates at time of writing