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Pound dominates this week, and probably the next

The British Pound dominated currency market headlines this week. Action being driven by Wednesday’s Bank of England (BoE) Inflation Report, in which the 2014 GDP forecast was revised higher. Following a series of better than expected economic data results, most notably in retail sales & employment statistics, the BoE now expects the UK economy to grow 3.4% in 2014, up from 2.8% previously.

Based on the updated GDP expectations, the BoE seems likely to move on rates until early 2015 (versus 2016 before). While this pushed the schedule forward as far as the BoE is concerned, it is roughly what the money-markets had priced in prior to Wednesday’s event.

This news put the Sterling on the offensive in a big way. As the week draws to a close the British unit has made big gains against all of its major peers, most notably the Greenback, Cable touching its strongest value since April 2011 this week. Sterling also approached 1-year highs against the Euro this week. Generally speaking if you look at a 6-month or 1-year time frame, there is almost no currency a Sterling seller hasn’t benefitted against. However it’s not all good news for the British unit.

In his opening comments BoE Governor Carney acknowledged the revised growth expectations and that unemployment had declined more quickly than initially expected””to 7.1% from 7.8% 6-months ago. However he qualified the admission by noting that the UK recovery was not yet self-sustaining and that the housing market & business capital spending weren’t ready for higher rates. He went on to state that disappointing productivity, ongoing economic slack, downside inflation risks, weak wage growth, disproportionate employment gains in part-time roles, and decreasing household savings were worrisome. As such he pledged that the BoE would not “take risks with the economic recovery”.

As was widely expected and with his pledge in mind, Carney retreated from his original forward guidance, which tied the central bank’s benchmark interest rate an unemployment threshold of 7.0%. The new Forward Guidance 2.0 is a complex multi-element objective that links future interest rate hikes to ‘spare capacity’, a notoriously difficult to measure target.

This murky new policy provides the BoE with the flexibility to hold on rates until it’s satisfied that the recovery is sustainable. Once the euphoria of the increased GDP forecast wears off, the uncertainty of this could pose a downside risk to the Sterling.

Next week sees UK employment statistics on Wednesday. Lately, due to Forward Guidance 1.0, which explicitly tied the BoE benchmark interest rate to the headline unemployment number, this data was the most hotly anticipated release on the UK economic calendar. Now that version 2.0 has dropped the unemployment link, it stands to reason that the headline number, while still insightful, isn’t as meaningful as it once was. The BoE’s new less-specific ‘spare capacity’ target, forces markets to take a more holistic approach analyzing to data. Specifically, when it comes to the employment statistics, things like average earnings and the proportion of new jobs created that are full-time versus part-time will take on new importance.

**Part 2 of Fed Chair Janet Yellen’s Testimony was postponed from Feb 13th due to weather concerns. A new date has not been set.

More: Pound dollar forecast.

David Starkey

David Starkey

David Starkey is a currency options dealer and market analyst for Cambridge Mercantile Group. A fascination with the everyday impact of globalization on society led David to pursue a degree in International Business from the University of Victoria. From there Forex was a natural fit. He has worked as a currency trader, risk manager, and hedging expert in both Canada as well as the United States for several non-bank brokers. Cambridge Mercantile Group.