© Reuters. FILE PHOTO: Wads of British Pound Sterling banknotes are stacked in piles at the Money Service Austria company’s headquarters in Vienna, Austria, November 16, 2017. REUTERS/Leonhard Foeger/File photo

By Saikat Chatterjee

LONDON (Reuters) – Sterling strengthened against the euro and dollar on Wednesday after data showed British inflation unexpectedly jumped above the Bank of England’s 2% target in May, sparking some concerns that policymakers may start signalling a shift in policy thinking if prices shoot up further.

Inflation hit 2.1% in May, outpacing forecasts and looks set to rise further as the country re-opens its economy after its coronavirus lockdowns.

Against a broadly steady dollar, the British pound rose 0.2% to $1.4112, homing in on a 2021 high of $1.4250 hit at the start of June. Against the euro, the British currency rose 0.25% to 85.94 pence.

While the rise in inflation is largely driven by local factors, the BoE will be keenly watching whether a stronger currency will help ease price pressures.

The British currency is one of the best performing currencies versus the dollar this year with a net 3.3% rise so far in 2021.

Sterling has staged an impressive rally from a 35-year trough it plumbed in March 2020 at $1.1413 and is about 6% below the $1.5022 level it recorded before Britain’s June 23, 2016, vote to leave the European Union.

“This transient inflation surge explained away by many central bank chiefs is at risk of becoming something more permanent or at least that continues to be the overhanging concern for markets,” said Charles Hepworth, investment director at GAM Investments.

Traders now turn their attention to the BoE’s monetary policy committee (MPC) meeting next Thursday, where it is expected to leave policy unchanged. The BoE has said it expects inflation to hit 2.5% by the end of this year before settling back to its 2% target.

“Recent comments suggest some concerns are possibly starting to seep into the MPC’s thinking regarding just how strong these downward pressures might turn out to be: if employment levels hold up as the furlough scheme ends then we could start to see the MPC’s message become increasingly less-dovish,” said Stuart Cole, head macro economist at Equiti Capital.

In response to Wednesday’s data, two-year British government bond yields rose nearly one basis point to 0.11%, a one-month high.

(Graphic – Brexit: a rollercoaster ride for the pound – https://fingfx.thomsonreuters.com/gfx/buzz/ygdpzxgbmpw/Pasted%20image%201623832414711.png)

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