UK Reports Inflation Tuesday

The UK reports Feb inflation numbers tomorrow. After the Feb release of Jan figures, BOE's King had to write a letter to Chancellor Darling to explain the overshoot.

King explained that the inflation was due to temporary factors and that over time it will ebb due to the abundant slack in the economy. The data, including surveys, have generally been soft. Of special note was the 0.9% decline in January manufacturing output (the concensus was for a small increase) and a widening trade deficit.

Employment data last week was the main upside surprise, with unemployment claims falling 32.3k in Feb and the Jan series was revised to only a 5.3k increase instead of 23.5k as initially reported.

Consumer prices are expected to have moderated with the year-over-year rate slipping back toward 31.% according to a couple of news wires surveys, from 3.5% in January. The core rate is expected to be steady at 3.1%.

Given that the budget will be unveiled on Wed, the CPI data may not spur a significant move. As we have noted, UK debt instruments have generally under-performed most in Europe this year, but in the past month it has played some catch-up. In the past month, the 10-year gilt yield is off 31 bp compared with 20 bp decline in Germany.

Short-sterling has also rallied over the past month, with the Dec 10 contract implying a 10 bp lower yield than it did on Feb 22. On the other hand, Dec Euribor is off 16 bp. So while the 10-year gilts has out-performed Germany over the past month, short-sterling has lagged behind Euribor.

The curve flattening that this implies is still evident if one uses the 2-year instead of the very short-end. The UK curve has flattened by about 40 bp over the past month. The flattening is a result of a 9 bp backing up in the 2-year yield and the rally noted above in the 10-year. By comparison, the German curve has flattened in a bullish fashion with the 10-year yield falling more than the 2-year yield.

The flatter UK curve seems consistent with the prognostications of a weak economic recovery and subdued price pressures Yet the US curve has also flattened. In the US case, supply considerations may be playing a larger role. It terms of economic outlook, economists are beginning to fine tune their expectations for the next batch of jobs data. The early consensus is coming in around 200k.

After testing the downside earlier, sterling bounced back in the North American session, but appears to be running out of steam near $1.51, which corresponds to a retracement objective of the slide from last week's high just shy of $1.54. Hourly momentum studies are extended and appear to be turning down. Although frayed the $1.50 area still offers support.

Earlier today, sterling lost ground against the euro too. The single currency firmed to almost GBP0.9050. This is an important chart area. It held and the euro was a sold back toward GBP0.8970. This may denote the near-term range ahead of the UK CPI report.