Since January 2007, the pound has dropped -23.5% against its major trading partners with the decline against the euro slightly more than that against the dollar. Although the pound managed to gain against most of these partners in 2009, much of the return was erased in the second half of the year as the BOE committed to adopt extremely loose monetary policies and economic contraction was more serious than previously anticipated.

In 2010, we expect the pound will remain weak in the first quarter, as there are still uncertainties in how the nation's economy will develop and whether the central bank will expand or unwind stimulus policies. However, things may be clearer towards the second half of the year. More rapid economic growth (compared both with 2009 and with other OECDs) and improvement in fiscal conditions may help lift the pound. That said, 2010 will be a year full of variables in the UK. The election, exit of monetary policies, and return of VAT to 17.5% are all important issues for the British economy this year, and their impact on economic development and the nation’s currency are yet to tell.

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Economic Outlook: The economy should have grown slightly in 4Q 2009 after contracting almost -6% in the first three quarters. Forward-looking indicators have been improving and net trades have been boosted by weakness in the pound (against a basket of currencies, sterling has dropped more than -20% since 2007 and -4.4% since July 2009). In 2010, recovery is expected to continue, although the path should be gradual and bumpy—a situation similar to most advanced economies. The OECD forecast UK's GDP to expand +1.2% in 2010 and +2.2% in 2010, after tumbling -4.7% in 2009.

These are compared with corresponding growths of +0.9% and +0.9% in the euro zone and +2.5% and +2.8% in the US.

The UK inflation jumped +2.9% y/o/y in December, +1% higher than the increase in November as oil price rallied while reduction in sales tax in 2008 was not repeated. This is the first time since May that inflation has exceeded BOE's target of 2% and we forecast the rise may speed up in coming months as VAT has returned to 17.5% from 15% last year, since January 2010. However, this is premature to predict an early tightening by the central bank. In fact, the MPC expected a spike in CPI. At November's inflation report, the BOE said that inflation will accelerate and then dip below the 2% target and the rate will not return to the target until 2012.

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