The dollar strengthened after US data revealed a faster-than-expected rise in consumer price inflation in January, raising fears the Federal Reserve may not be able to keep cutting interest rates as aggressively as markets hope.

The Labor Department said overall prices rose 0.4 pct, slightly above the 0.3 pct rise expected by economists polled by Thomson's IFR Markets, and pushing the annual rate of inflation back up to November's two-year high of 4.3 pct.

Core inflation, which strips out volatile food and energy prices, rose 0.3 pct in January, slightly more than the 0.2 pct expected. On an annual basis, core inflation was up 2.5 pct year on year, the highest since Feb 2007.

'This rebound in inflation couldn't have come at a worse time for the Federal Reserve,' said Paul Ashworth, senior US economist at Capital Economics.

'Persistently high inflation could take away the Fed's flexibility to respond more aggressively to reduce borrowing costs, just at the time it needs that flexibility the most,' he added.

US housing starts figures were also released by the Commerce Department and showed a modest rebound, rising 0.8 pct to a 1.012 mln unit annual rate, very slightly above Thomson IFR Markets' expectations for 1.010 mln units.

'This remains very low historically but the mere fact that starts did not fall any further may be seen as a relief,' said Audrey Childe-Freeman, senior economist at CIBC World Markets.

The strength of the US data added to the pound's woes, pushing it briefly to a four-week low against the dollar at around 1.9360 usd.

The pound had already come under pressure earlier after the Bank of England's latest interest rate deliberations, revealed this morning, suggested more rate cuts ahead.

The currency has been on the back foot all week, with the nationalisation of ailing mortgage lender Northern Rock adding a new sense of uncertainty at a time when the overall economy is predicted to slow rapidly.

Also this week, two BoE rate setters appeared to signal that they remain in the rate cutting camp. Independent members of the rate setting panel, Tim Besley and Kate Barker both highlighted downside risks to the economy.

Today, it emerged that while the majority of rate setters chose to lower rates by a quarter point to 5.25 pct earlier this month, there was one dissenting vote for a more dramatic 50 basis point reduction from arch-dove David Blanchflower. Markets had been betting on a unanimous vote.

'The Bank of England remains on course for lower rates as the central Monetary Policy Committee concern remains the risk of weaker growth ahead,' said David Brown at Bear Stearns. (NYSE:BSC)

'The easing bias remains intact, especially while the MPC remain worried about the fall-out effects from the credit crunch on the economy,' he added.

Attention will turn back to the US tonight, with the minutes to the Fed's last rate setting meeting of Jan 30 due, which will also be accompanied by its latest forecasts for GDP growth, inflation and unemployment.

'Since the forecasts are not quarterly, they will not clearly tell us whether the Fed is forecasting two consecutive quarterly growth contractions (ie recession), but markets could come under severe pressure once the Fed affirms further slowdown in its forecasts as chairman Ben Bernanke alluded to in last week's Congressional testimony,' said Ashraf Laidi, chief FX strategist at CMC Markets.

In his testimony to the Senate Banking Committee, Bernanke had predicted there would be a 'period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year as the effects of monetary and fiscal policy stimulus begin to be felt'.

London 1542 GMT London 1226 GMT

US dollar
yen 107.99 up from 107.85
sfr 1.1005 up from 1.1003

Euro
usd 1.4651 up from 1.4645
stg 0.7552 up from 0.7539
sfr 1.6125 up from 1.6116
yen 158.24 up from 157.95

Sterling
usd 1.9399 down from 1.9424
yen 209.49 down from 209.50
sfr 2.1349 down from 2.1376

Australian dollar
usd 0.9135 up from 0.9134
stg 0.4707 up from 0.4705
yen 98.63 up from 98.52

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