On Tuesday, March 23rd UK February CPI will be released. The February CPI is expected at 0.5% compared to -0.2% last month. On an annualized basis UK February CPI is expected to fall to 3.1% from 3.5% last month. Despite a likely deceleration of the UK annual rate of inflation in February the inflation rate will remain above the 3% upper limit of the BOE's inflation target. The recent rebound in GBP and rally back above 1.50 is attributed to rising UK inflation expectations, improvement in the UK labor market and diminished speculation that the BOE would extend quantitative ease. In January, UK inflation accelerated at its fastest pace in 14 months.UK February claimant count dropped by 32.3k, an 8.2k rise was expected. The February BOE policy minutes state that some board members are becoming more concerned about inflation. The BOE policy minutes state that UK CPI will remain above target in the months ahead and that there is a risk that the public's expectations of inflation may begin to rise. The BOE inflation target is 2%. UK CPI rose to 3.5% in January. The rise in UK CPI and uncertain fiscal outlook complicates the outlook for BOE policy.

 In February the BOE voted unanimously to hold rate policy unchanged at 0.5% and maintain the current level of asset purchases at £200bln. BOE officials see a mixed outlook for the UK recovery. BOE Governor King said he expects a gradual UK economic recovery. The BOE's Sentance said he sees the risk of a double dip recession in the UK. Sentance's statement and the mixed outlook for the UK recovery encourages speculation that the BOE may be forced expand quantitative ease. The CBI warns that the UK faces a slow and sluggish recovery. The outlook for the UK recovery is clouded by UK fiscal outlook and election uncertainty. Ratings agencies have placed the UK on notice that the UK AAA sovereign debt rating is at risk of downgrade if the government does not take credible action soon to reduce its deficit.UK net public borrowing rose by 12.4bln in February.  The UK is expected to hold a general election on May 6th. The election is seen as critical to the outlook for the UK budget deficit. The Conservative Party has pledged to take quick action to reduce the deficit. The leader of the Labor Party Brown says he is concerned that rapid action on the deficit could hurt the UK recovery. A number of UK election polls suggest that the UK election may end in a hung parliament. A hung parliament would make it difficult to gain a parliamentary consensus on budget deficit reduction. The latest UK election polls suggest that the Conservatives may gain a parliamentary majority. A Conservative majority could reduce the risk of a near-term downgrade of UK debt rating and may contribute to additional pressure on the BOE to consider expanding quantitative ease. Further expansion of quantitative ease would be a negative for the GBP.

 The debate is whether rising UK inflation risk will encourage the BOE to maintain steady policy or the uncertain outlook for the UK recovery and budget will encourage the BOE to expand quantitative ease. BOE officials indicate that CPI will guide decision on monetary policy and whether to expand asset purchases or withdraw stimulus. A higher than expected CPI report Tuesday could be a mild positive for the GBP as the data could dampen BOE ease speculation.  Despite the acceleration of UK inflation in January the BOE expects inflation to fall below 2% target over the next two years.

 Ahead of the May 6th UK general election the BOE is likely to leave policy unchanged. The election result may have a greater bearing on BOE policy going forward. If the UK election produces a strong enough majority in parliament that will allow conservatives to take action to reduce the budget deficit the BOE will have to take the budget outlook into the calculus for its monetary policy. The major concern is that pressure to reduce UK budget deficit could be a drag on the UK recovery. If credible reduction of UK fiscal spending emerges the BOE may have to maintain a bias towards quantitative ease despite rising inflation expectations.

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