British pound (GBP) outlook uncertain even as Bank of England tipped to bring forward rate hike date

Outlook for the British Pound: The Bank's Inflation Report report comes a day after the UK currency experienced hefty declines owing to the falling rate of inflation in the UK.

Foreign exchange markets are betting that the falling rate of inflation will afford the Bank of England the chance to keep interest rates at record lows for longer.

However, Berenberg Bank's Chief UK Economist, Rob Wood, says the Bank will bring forward their date for an interest rate hike:

"In Wednesday’s quarterly Inflation Report, we expect the BoE to shift the date at which unemployment reaches the 7% threshold for considering a rate hike to Q4 2015 from Q2 2016."

But, sterling bulls should be warned that the underlying tone could still be dovish:

"The latest data are unlikely to dramatically change the BoE’s assessment that rates should stay on hold for a long time because the supply side is improving along with demand. The message is likely to be that the UK has a long way to go, and the UK is in the early stages of a recovery that still needs a lot of stimulus."

Such conflicting signals could make for volatile trading conditions.

Pound sterling takes a nose dive

The British pound (GBP) has come under pressure across the FX markets on Tuesday with an extraordinary bout of selling on the back of what are not necessarily extraordinary inflation numbers.

Carl Hasty, Director of Smart Currency Business comments on the outcome:
"Sterling has this morning taken a sharp nosedive after inflation figures from the country fell to the lowest level in a year, Consumer Price Index saw the smallest increase since September 2012."

"The release was expected at 2.5% but disappointed markets coming in at  2.2%, causing a significant drop in the markets as it puts less pressure on the Bank of England to raise its interest rates. Notably the pound reached its lowest point in almost two months against the US dollar, while also dropping significantly from the recent highs against the euro."

But, the outlook is not all that bad

Despite the hefty selling in GBP, there are those who believe declines for sterling will be underpinned by the improving economic picture of the UK.

"Cable quickly crumbled on the news breaking through the 1.5900 barrier before finding support just ahead of the 1.5850 level," says Boris Schlossberg at BK Asset Management, "although the knee jerk reaction in the market was negative towards the currency, the longer term economic implications are likely to be positive for UK."

If tomorrow's labor data report shows healthy employment growth, the combination of falling prices and expanding economic activity should boost the pound and the pair could move towards the 1.6000 level once again suggests Schlossberg.