Sterling held near $1.30 on Tuesday as signs of progress in Brexit talks helped cement gains after investors pushed back expectations for when the Bank of England would cut interest rates below zero.
The pound was last down 0.1% at $1.2966 after topping $1.30 for the first time since mid-September. Sterling later fell into negative territory, before making up ground after Reuters reported that Britain and the European Union were moving “closer and closer to a deal”.
European Union diplomats told Reuters that Brussels was gearing up to negotiate until as late as mid-November — rather than cutting talks off at the start of next month — to avoid a damaging “no-deal” scenario when Britain’s standstill transition with the bloc ends on Dec. 31.
Sterling last traded down 0.1% against the single currency at 90.91 pence.
Cautious optimism that London and Brussels would reach a deal has been growing in recent days, and most analysts now expect the two sides to do so before the transition deadline.
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“We’re getting closer and closer — the talks are miraculously getting slightly warmer,” said Mark Holman, CEO at TwentyFour Asset Management.
“For us looking from financial markets, it does seem stupid not to get a deal done … If you ask me today, I think it’s probably 50:50.”
Earlier, sterling had touched $1.3007, its highest since Sept. 18.
That mark came as money markets pushed back bets that Britain’s interest rates would turn negative, with investors now seeing rates falling below zero in May 2021. Previously they had expected the Bank of England to cut rates into negative territory in March.
The BoE, which cut borrowing costs to a record-low 0.1% in March, is looking at whether it is technically feasible to cut its main interest rate below zero, something that has already been done in Japan and the euro zone.
Bank of England rate-setter Jonathan Haskel said on Monday he saw downside risks to the economy — and also some possible benefits — from cutting interest rates below zero.
“They are still keeping the option open that negative rates could help support the recovery,” said Lee Hardman, currency strategist at MUFG.
Sub-zero rates would likely weaken the pound, at least in the short term, he added.
The pound advanced towards $1.32 on Friday, on track for its biggest monthly rise in more than a decade as a broad-based dollar decline fuelled demand for the British currency.
But concerns of a second wave of infections, a weak economy and growing pressure to strike a Brexit trade deal before a transition period ends in December are prompting investors to become wary of the currency’s prospects in coming months.
Bank of America Merrill Lynch strategists, who have been bearish on the pound, said the rest of 2020 could see weakness in the currency, especially as the period of August through December historically contains four negative months for sterling.
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“The fortunes of the pound will increasingly be driven by the monetary policy stance, the ability of the economy to rebound from the global pandemic, and Brexit negotiations, which are effectively stuck in the mud,” the strategists said.
On Friday, the pound rose 0.5% to $1.3159, its highest level since early March. On a monthly basis, it is up nearly 6%, its biggest rise since May 2009, according to Refinitiv data.
The pound’s gains can be attributed to the dollar’s losses.
The greenback has fallen nearly 5% in July, with most of the drop coming in the last 10 days as new cases of coronavirus surged across several U.S. states and some recent data pointed to an economic recovery losing steam.
British Prime Minister Boris Johnson said on Friday some lockdown easing planned for the whole of England would need to be delayed and the country’s chief medical officer said any further opening up of the economy would raise infection rates.
Concerns over the struggling economy have prompted hedge funds to unwind their bullish bets on the pound in recent weeks while derivatives data signal more weakness ahead.
Sterling headed for its first positive week in four against the dollar on Friday, holding below the $1.25 mark as a week of negotiations between Britain and the European Union ended prematurely, with meetings expected to resume next week.
The pound slipped briefly in morning trading in London, a move one analyst attributed to some spillover of political uncertainty in Europe following the resignation of French prime minister Eduoard Philippe and the appointment of his successor.
By 1509 GMT, the pound was trading flat to the dollar at $1.2464.
It also traded flat against the euro, at 90.16 pence.
Sterling has risen 1.2% against the dollar this month, after losing 2.7% in June.
“The more consolidative tone of the pound is likely related to the fact that it is the worst performing G10 currency on a 1 month view – investors are likely pausing and evaluating new news,” said Jane Foley, head of FX strategy at Rabobank.
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Brexit talks this week between Britain and the EU ended early on Thursday, with a meeting between the chief negotiators on Friday cancelled.
The EU’s chief negotiator, Michel Barnier, on Thursday said serious divergences remained between the two sides after talks this week on their future relationship.
British Prime Minister Boris Johnson said on Friday he was more optimistic than Barnier that a post-Brexit trading deal could be struck, but said Britain could leave the bloc without a comprehensive agreement if needed.
Implied volatility on the pound – as shown by options markets – remains elevated compared with other currencies.
“There are some positive headlines connected with the latest Brexit talks,” Foley said.
UK Chief negotiator David Frost has described the talks as “comprehensive and useful”, she noted, while adding the fact that significant difference remain would keep investors cautious.
The longer the wait for concrete news on Brexit the more likely the pound sterling is to push lower. The huge political uncertainty suggests that volatility is likely to remain higher than other G10 peers, Foley said.
Forecasts of a deeper UK recession relative to other European countries, the possibility of negative interests from the Bank of England and Brexit have all weighed on the pound in recent weeks.
A historic slump across British businesses levelled off last month as some of the economy reopened following an easing of the coronavirus lockdown, a business survey showed.
The IHS Markit/CIPS UK Services Purchasing Managers’ Index (PMI) rose to 47.1 from 29.0 in May.
Sterling rose against the dollar on Monday, as plans to ease coronavirus lockdowns in the UK and signs the economy may bounce back due to pent-up demand kept the currency just below the $1.27 touched late last week.
Analysts warned, however, that Brexit remains a risk for the pound – which has rallied for seven consecutive days against the dollar – as talks with the European Union fail to make progress.
The pound has risen 2.8% against the dollar this month as several economies re-open from lockdowns, weakening demand for the U.S. currency.
British Prime Minister Boris Johnson is planning to relax rules on outdoor dining and weddings, as well as speeding up government investment plans to limit the economic damage from the coronavirus, newspapers reported on Saturday.
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The Sunday Times said Johnson wanted to relax planning restrictions that stop many pubs, cafes and restaurants from using outside areas, and also to make it legal to hold weddings outside.
The number of British shoppers in early June indicate pent-up demand for shopping in physical stores as the coronavirus lockdown is eased, industry data showed on Monday.
Britain went into lockdown on March 23 to slow the spread of the pandemic, with all retail stores deemed non-essential forced to close.
By 0828 GMT, sterling was up 0.15% against the dollar at $1.2686, just below Friday’s $1.27. It was weaker against the euro by 0.12% at 89.10 pence.
“Sterling-dollar remains anchored around the 200-day moving average of $1.2660/65. But it seems that bar the broader weak dollar and positive risk environment, investors currently lack any major catalyst for the pound to move materially above this key level,” said Viraj Patel, FX and global macro strategist at Arkera.
“We could see the pound tread water around these levels in absence of any further positive catalysts and investors take stock of what will happen next in broader markets – especially ahead of the Fed meeting later this week. However, with Brexit headwinds also coming to the forefront of investors – the risks are mildly tilted to the downside for the pound this week.”
Johnson is willing to accept European Union tariffs on some UK goods in an attempt to win a trade deal and break the deadlock in talks with the EU, the Daily Mail reported. Britain’s chief negotiator, David Frost, had made a new offer, the newspaper said, citing sources.
According to the offer, the UK would accept tariffs on a small number of goods in return for the EU’s dropping its demand that Britain continue to follow EU rules.
Speculators increased their net short position on sterling in the week to last Tuesday, CFTC data showed on Friday.
The pound rose above $1.27 and was set for its biggest weekly gain against the dollar since the end of March on Friday, even though European Union and British negotiators said there had been little progress in Brexit trade talks.
Britain left the EU in January and there are just weeks left to extend a year-end deadline to reach a trade deal.
A transition arrangement that keeps previous rules in place during talks expires at the end of 2020 unless both sides agree to extend it this month, which Britain has said it will not do.
“The market thinks there’s still a better than 50% chance that we’ll muddle through again,” said Kit Juckes, FX analyst at Societe Generale, adding that the risk of not reaching a deal was a background worry for sterling.
The pound, which has gained more than 3 cents in a week, rose as high as $1.2705, its strongest since March 12.
Against the euro, which gained further after the European Central Bank’s latest stimulus plan, the pound reached 89.04 pence, having retreated from the 90 level it briefly broke above late on Thursday.
The pound has gained 5% against the dollar since reaching a low of $1.2075 in mid-May, but has been held back by Britain’s high coronavirus death toll, Brexit-related risks, the prospect of negative interest rates and a growing debt pile.
It gained when the Bank of England’s executive director for markets said that a negative interest rate would not be introduced in the near term.
“If the UK goes down the road of negative rates, it would be the first country with a negative current account deficit to do so, putting downward pressure on sterling,” Deutsche Bank economist Sanjay Raja and macro strategist Oliver Harvey said in a note to clients.
“This could see inflation jump at a time when the Bank is looking to shore up confidence and support the economy through the recovery,” they added.
The weakening dollar played a role in sterling’s rise.
“The Federal Reserve is employing massive monetary expansion, and political tensions in the US cement that stance even further. Both have already contributed to a rebound in GBPUSD and will continue to do so,” Thomas Flury, head of FX strategies, and Dean Turner, economist at UBS Global Wealth Management, said.
Sterling has plunged to its lowest level against the US dollar (GBP/USD) since October last year on the back of global coronavirus-related uncertainty.
The pound crashed as low as 2.36 per cent against the dollar today to fall to just $1.2517, as traders flocked to the greenback.
By 5.35pm it stood 1.63 per cent down at $1.261.
The sterling sell-off came on another punishing day for UK stocks, with the FTSE 100 index suffering its worst one-day plunge since 1987 to book a 10.9 per cent drop.
US President Donald Trump’s decision to ban all travel from Europe to the US, except from non-Schengen zone countries like the UK and Ireland, spooked traders.
Analysts explained a huge global sell-off of volatile assets in reaction to the ban has driven up the dollar’s value.
Tajinder Dhillon, senior research analyst at Refinitiv,said: “Covid-19 and a collapse in oil prices have caused a plunge in risk assets. The S&P 500 has entered into a bear market, falling over 20 per cent from its February peak. This has led to a flight to safety including bonds, gold, and Japanese Yen.”
And Ranko Berich, head of market analysis at Monex Europe, added: “We are seeing multiple markets across the globe with extremely unusual amounts of volatility.
“The main takeaway right now is markets are convulsing with extreme amounts of fear and risk aversion. Today that has manifested as a massive bid for US dollars.”
“It is cash pouring into the dollar that pushed sterling to current levels. We see the same across all currencies,” added Ipek Ozkardeskaya, senior analyst at Swissquote Bank.
“Investors may be piling into cheap US dollars with cash liberated from European indices sales.”
Trump travel ban sinks sterling and euro
Trump defended the measure today as a move to defend the US from a rise in coronavirus cases. But observers warned of the impact on global trade.
The travel ban prompted traders to send the FTSE 100 into coronavirus freefall as they quit UK stocks in their droves.
“The travel ban is a decisive step to prevent the spread in the US but will cripple trade between the two continents,” London Capital Group’s Jasper Lawler said. “Goods will still flow but presumably at reduced pace and trade in services will almost grind to a halt.”
Investors piled into safe haven assets like US Treasury yields, which traders buy in dollars, pushing up the value of the greenback. The dollar is increasingly seen as a safe haven asset, in part due to its dominant use in global payments.
The euro also fell 0.61 per cent against the dollar to $1.119 after the European Central Bank (ECB) failed to restore market confidence with stimulus measures this afternoon.
But sterling tumbled against the euro too, sinking 1.05 per cent to $1.1268 by 5.35pm.
“The dollar has been left as the last haven standing,” Berich said.
He added the massive sell-off has driven demand for liquidity, which has boosted the greenback.
“We are seeing a lot of reports of a lack of liquidity in the US. There’s companies looking for liquidity and banks are attempting to provide cash to offer that liquidity. That has created a shortage of physical cash so the price of the dollar has gone up,” Berich explained.
Global stocks crash in market rout
Global stocks sank deep into the red today in an almost unprecedented day of market turmoil.
The FTSE 100 crashed 10.1 per cent to just 5,282.4 points and Europe’s Stoxx 600 crashed 11.1 per cent.
Similar sell-offs were seen in the US as the New York Stock Exchange halted trading after the S&P, Dow Jones and Nasdaq all fell by more than seven per cent within minutes of the market opening.
The sharp drop in US stocks triggered circuit breakers, which halt trading on the markets for 15 minutes.
It is the second time this week the automatic system has been activated to curb panic selling.
That did not calm traders, however, with the S&P 500 down 8.8 per cent, Dow down 9.2 per cent and Nasdaq down 8.4 per cent by 4.15pm.
Markets in ‘panic mode’
Bond yields have continued to decline in the US and the UK, indicating people are flocking to less risky investments.
Forex trading platform Equals’s chief economist, Jeremy Thomson-Cook, said global markets are in “panic mode”.
He said: “At the moment, investors are looking to financial institutions and governments to stand up and commit something to fighting this downturn. The ECB has had to call out governments to open their wallet and last night’s address from the White House was met with disbelief as to its lack of a plan beyond flight bans. The time for action is now or we are going to be talking about credit crunches again.
“Sterling is caught in the middle; a currency that has lost its haven status courtesy of Brexit while investors hold dollars as the global reserve currency.”
The British Pound came under sustained selling pressure at the start of the new week as markets repriced the currency on account of ongoing coronavirus fears and expectations for turbulent EU-UK trade negotiations, which have officially commenced today.
Despite the promise of extra support from global central banks, hopes for a decisive rebound in global equity markets are yet to transpire and according to one noted UK economist the deeper the economic impact of the virus outbreak, the greater the risk to Sterling.
“Sterling relies on a steady stream of external finance to maintain its value; rising risk aversion will hurt it,” says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics, an independent economics research organsiation. “Sterling won’t be a safe haven if Covid-19 triggers a global slump.”
Global markets unravelled four months worth of gains last week and the Pound has begun to react negatively to bouts of market fear over coronavirus and is now well off its 2020 highs and looks increasingly intent on entering short-term downtrends against a number of currencies.
Market expectations for an interest rate cut at the Bank of England in March have meanwhile risen to 65% on Monday suggesting the market is currently pricing in a rate cut. When expectations for an interest rate cut at a central bank grow, the currency it issues tends to decline in value. This dynamic could well be at play. “In the wake of recent rumours regarding global interest rate cuts, the Bank of England may be forced to envisage an easing of monetary policy earlier than previously expected,” says Marc-André Fonger, Head of Research at Fongern FX.
Pantheon Economics have meanwhile on Monday said they now expect the Bank of England to deliver a rate cut at the March meeting.
“We fear… that Sterling will be one of the currencies hit hardest if the coronavirus becomes a fully-fledged pandemic and pushes the global economy into recession,” says Tombs. The Sunday Times ranked Tombs as the most accurate forecaster of the UK economy in 2014 and 2018 while Bloomberg consistently has ranked Samuel as one of the top three UK forecasters, out of pool of 35 economists, throughout 2018 and 2019.
A first case of coronavirus was identified in England on Saturday in which the disease was thought to have been “passed on in the UK,” Chief Medical Officer Chris Whitty said.
The man was found in an undisclosed part of Surrey and there is now an urgent effort underway to identify how he came to have the virus as well as all individuals who’d been in contact with him. Since then a primary school teacher Reading, Berkeshire has been confirmed to be suffering from coronavirus, leading the school to close temporarily.
According to Tombs, the UK’s still relatively small number of coronavirus cases means the Bank of England might be less inclined to cut interest rates than their global peers in countries where the outbreak might be more severe. In theory this should provide a relative advantage for Sterling currencies of central banks that are cutting rates tend to fall relative to currencies of central banks that are raising, or maintaining, their interest rates.
Pantheon Macroeconomics tell clients the U.K. economy is better placed than many other economies to weather the pandemic.
“Britain’s manufacturing sector is a minnow, while the country’s status as a net importer of tourist services – outbound tourism exceeds inbound tourism by 50% – means that a sudden grounding of all flights or increased reluctance to take trips overseas might boost domestic expenditure,” says Tombs.
However, the apparently benign status of the UK economy amidst a global outbreak might simply not be enough to keep Sterling supported.
“The Pound is a structurally weak currency and it remains sensitive to global investors’ appetite for risk,” says Tombs.
“Large capital inflows are required to keep sterling stable, given that the U.K. runs a persistent current account deficit, equal to nearly 4% of GDP. Sterling depreciated by 25% during the 2007/08 crisis primarily due to a global pullback in cross-border finance, not a material shift in interest rate differentials,” adds the economist.
Global markets continue to reflect rising investor fears that the outbreak – and attempts to prevent the disease from spreading – will cause a substantial global economic slowdown.
China this weekend released data that showed containment measures enacted at the start of January had severely restricted economic activity. The Composite PMI – which gives a snapshot of economic activity for February – fell to a record low of 28.9, having been at 53.0 in January.
During the financial crisis of 2008 the activity indicator only went as low as 38.8.
The real risk for those holding stocks, and indeed for the British Pound, is that this slowdown persists into March and other economies start to show contagion effects. However, one analyst we follow says the worst might have now been passed for China.
After weeks of preparation the EU and UK are to officially commence trade negotiations in Brussels. Round 1 commences on March 02 and ends on March 05 with four further rounds ending on Saturday May 16.
The progress of talks should form the immediate domestic focus for the Pound this week.
The two sides appear to be far apart on some key issues, particularly the degree to which the UK follows EU rules and regulations in order to achieve its desired objective of tariff-free trade.
We expect talks to be arduous and unlikely to be fully finalised before the UK’s self-imposed year-end deadline.
This is likely to create a level of uncertainty that should ensure Sterling’s strength is ultimately restricted and ensure strength remains limited. The downside potential is however elevated on any signs that the UK and EU are unable to achieve the kind of trading relationship struck by the EU and Canada in 2014.
“Prime Minister Johnson warned that if the EC denies it the Canadian-like agreement, the UK will walk away from talks at the end of Q2. The EC negotiators have made it clear that such a deal with the UK would require regulatory alignment, which the UK cannot accept. This issue is to the trade talks that Ireland was to the divorce agreement, nearly impossible to resolve without transgressing redlines of one side or the other,” says Chandler.
The pound to US dollar rate ended last week on the backfoot, after briefly dipping below the 1.30 level on Friday. Already concerned about the Bank of England’s (BoE) interest rate outlook – which kept the possibility of cutting the cost of borrowing on the table in 2020 – the pair was left to digest the central bank’s second big announcement of the week. Mark Carney’s replacement as the governor of the BoE was revealed on Friday: Andrew Bailey, a BoE stalwart, will step into the role next month, creating further uncertainty about UK interest rates in the months ahead.
Interest rates weren’t the only factor weighing on the GBP vs USD pair. A sudden revival of no-deal Brexit fears, combined with dollar strength, also contributed to its downward spiral from a high of 1.34 on Monday. Boris Johnson’s suggestion earlier in the week that he would prevent the extension of the Brexit transition period, led to concerns that the upcoming negotiations could fail to deliver a comprehensive deal; a scenario that could leave the pound sterling to USD rate balancing on another cliff edge.
US-China Trade Doubts Boost Safe Haven Dollar
The US dollar took comfort in encouraging domestic data, before being boosted by lingering US-China trade uncertainty. Any hint of optimism that the trade war between the two superpowers can be resolved has the potential to make the safe haven dollar unappealing. Therefore, further stagnation in talks about a ‘phase one’ deal can have the opposite effect.
Britain took a huge stride towards leaving the EU when Parliament finally passed the Brexit withdrawal agreement on Friday. Mr Johnson’s reward for achieving such a thumping election majority also included an amendment outlawing an extension to the Brexit transition period. While this could still be revisited in the coming months, the pound will be hoping the UK government favours a soft Brexit agreement over splitting from the EU as soon as possible. The only UK data of note over the Christmas week is Friday’s UK finance mortgage approvals.
Will a raft of ecostats provide the US dollar with some festive cheer? Today sees the release of Durable Goods Orders, Nondefense Capital Goods Orders (excluding aircraft), New Home Sales and the Chicago Fed National Activity Index. On Thursday Initial Jobless Claims figures hit the headlines. Dollar investors will also continue to monitor developments in the US-China trade war, although the Christmas break means they probably shouldn’t hold their breath.
The pound to US dollar interbank exchange rate stands at 1.3273 today. This is -1.74%, or more than -2.25 cents, below sterling’s recent 19-month high against the so-called greenback, its strongest since May 18th 2018, reached on December 12th, at 1.3509.
Sterling has fallen in value against the buck, in part because the UK economy decelerated in December, while America’s economic activity sped up, said trusted statistics released yesterday.
According to watchdog IHS Markit’s “flash” PMIs (Purchasing Managers Indices) for the UK’s services and manufacturing activity this month, the figures fell to 49.0 and 47.4 respectively.
These results were below forecasts for 49.5 for services, and 49.3 for factories, as well as both beneath the 50.0 figure that signals economic growth. This tells us that the UK economy has lost steam, weakening sterling.
US Manufacturing PMI Continues to Expand in December
Meanwhile, looking States-side, IHS Markit’s US services PMI for December rose to 52.2, above both forecasts for 51.9, as well as November’s result of 51.6. Also, US manufacturing activity came in at 52.5 this month, bang on forecasts, and only slightly below November’s 52.6.
This tells us that America’s business activity is both outperforming the UK at present, and in fact accelerating.
This reinforces US Federal Reserve Chairman Jerome Powell’s recent remarks that America’s economy is in a “good place” and cuts the odds that the US central bank will reduce interest rates below their current 1.5%-1.75% in 2020. This tends to support the US dollar.
Looking to this week, there are many factors that could affect the GBP to USD interbank exchange rate. These include the new UK Conservative government’s Brexit and spending plans, which may support the UK economy in 2020. They also include news about the US-Chinese trade war, following President Donald Trump’s recently signing the “first phase” trade deal. They also include economic data, such as today’s UK unemployment figures for October, and the Bank of England’s interest rate decision on Thursday. Meanwhile, US economic releases include today’s industrial production figures for November, and US GDP figures for Q3 on Friday, at 13.30 GMT. So look out for these releases, for their effect on the pound vs US dollar.
Pound Sterling bid higher on better-than-expected labour market data
Annual wage growth hits highest level since financial crisis
Bets growing again that Bank of England to raise interest rates before year-end
Pound Sterling was seen staging a recovery against the Euro and U.S. Dollar in mid-morning trade on Tuesday, June 11 after UK labour market data showed wages continue to rise.
According to ONS data, average earnings, with bonuses included, grew 3.1% in April, which was faster than the 2.9% growth markets were expecting.
The average earnings rate, without bonuses included, grew 3.4% in April, taking the year-on-year growth rate to 3.8%, its highest growth rate since 2008.
With inflation standing at 2.1%, UK consumers find themselves in a position where pay is easily outstripping price increases.
“Sterling jumps above $1.27 and the only G10 currency in green against the U.S. Dollar after April’s nominal wage growth increases a whopping 3.8%, the fastest one-month increase since May 2008 (excluding bonuses),” says Simon Harvey, FX analyst at Monex Europe.
The beat on expectations saw the Pound catch a bid as markets reckoned the data keeps alive the prospect of a Bank of England interest rate rise being delivered before 2019 is out.
Above: Sterling goes higher against the Euro following the release of UK labour market data.
Also proving supportive to Sterling was additional data that showed UK employment grew 32K in the three months to April, where markets were actually expecting employment to have contracted by 1K, ensuring the UK employment rate was estimated at 76.1%, higher than a year earlier (75.6%) and the joint-highest on record. The employment rate for women was 72.0%, the highest on record.
“The British labour market remains rather resilient and provides little cause for concern, as the unemployment rate continues to be unchanged at a very low level. Given that average earnings have improved steadily, we expect a slightly optimistic BoE in the near future,” says Marc-André Fongern, Head of FX Research at MAF Global Forex.
The Pound-to-Euro exchange rate is quoted at 1.1223 in the wake of the numbers, having been as low as 1.1193 earlier in the day. The Pound-to-Dollar exchange rate is quoted at 1.2709 having been as low as 1.2669. The data will come as a relief to the UK currency which remains has been caught in a relentless downtrend since early May, and we would expect any strength to be short-lived in nature as markets remain primarily focussed on UK political dynamics.
“Cutting through the political noise that dominates the column inches currently, sterling received a boost from another decent wage inflation release this morning. As I have suggested before, it was lagging earnings data which stayed the hands of the MPC previously when CPI was testing above 3%. Since this has flipped, and with headline inflation still remaining around target levels, it could be the wage data that tip’s the BoE towards a rate hike sooner than people realise,” says John Goldie, FX Dealer at Argentex, a foreign exchange brokerage.
The employment data suggests the Bank of England could raise interest rates sooner than financial markets expect. The data comes in the wake of BoE policymaker Michael Saunders comments made on Monday that the Bank would not necessarily wait until all Brexit uncertainties were resolved before raising interest rates again.
At a time when the U.S. Federal Reserve and European Central Bank are looking at potentially cutting interest rates, this stance should provide a supportive dynamic for Sterling against the Dollar and Euro.
Financial market pricing of future interest rates appear to betray an assumption that the BoE is more likely to cut rates than to raise them over the coming year, reflecting signs that trade conflict between the United States and China is hurting the world economy.
However, some analysts point out that the UK is not as exposed to international trade dynamics as the U.S. and Eurozone, and therefore the reasons for the Fed and ECB cutting interest rates do not necessarily translate into a ‘sympathy’ cut at the BoE.
If markets row back on their expectations for a BoE rate cut and align them once more with the view that a 2019 rate rise is likely, then we could well see Sterling find further support.
“This is a strong labour market report that bolsters the case of MPC members Andy Haldane and Michael Saunders who recently have re-emphasised the need for gradual increases in interest rates,” says Samuel Tombs, Chief U.K. Economist at Pantheon Macroeconomics. “With the labour market unlikely to weaken suddenly soon and government policies set to remain supportive of faster wage growth, the MPC can’t afford to ignore the constant inflation pressure now emitted by the labour market.”
Image courtesy of Capital Economics.
Text-book central banking rules state that interest rates must rise in order to keep inflation at a sustainable level, and one of the main drivers of inflation is wage growth.
A typical side effect of interest rate rises is a stronger currency as global investors channcel capital to where returns are expected to be higher.
Commenting on the future of UK interest rates in a speech hosted by the Institute of Directors at Southampton’s Solent University, the BoE’s Saunders said, “we probably would have to return to something like a neutral stance earlier than markets project… I want to stress that the MPC does not necessarily have to keep rates on hold until all Brexit uncertainties are resolved.”
Indeed, the BoE has raised rates twice since Britain voted to leave the EU, in November 2017 and August 2018.
Saunders says the ‘neutral’ interest rate is at about 2.0%, suggesting the UK can absorb a number of interest rate rises.
Andy Haldane, the BoE’s chief economist, meanwhile said in an opinion piece in Saturday’s edition of the Sun newspaper that the time was nearing “when a small rise in rates would be prudent to nip any inflationary risks in the bud”.
Other analysts are more circumspect on the latest set of labour data, suggesting that wage growth will moderate over coming months and this could ease back on expectations for an interest rate rise.
“The pick-up in core earnings seems driven by temporary drivers, such as a one-off public sector pay band increase and a pick-up in whole economy hours worked rather than actual hourly earnings growth. We believe the pace of earnings growth is likely to slow and stabilise over the coming months,” says Fabrice Montagné, an analyst with Barclays.
Barclays expect the recent slowdown in UK growth, as evidenced by Monday’s GDP data, to translate into weaker labour market dynamics.
“Recruitment agents continue to signal that permanent job placements declined steadily between March and May, implying risks to employment ahead (Figure 4). Meanwhile, vacancy growth in May slowed further, and the hiring of temporary workers continued to outpace that of permanent staff, providing further evidence that job creation remains temporary given the uncertain backdrop,” says Montagné.