Governor Mark Carney took a guarded stance this week at the Bank of England’s (BoE) Quarterly Inflation Report (QIR); focusing on the risk factors facing the British economy and the perils of raising interest rates too soon. Specifically Carney singled out Sterling’s performance against the Euro as a headwind facing inflation growth and that its strength was “relevant” for the path of interest rates.
Additionally, and in a nod to Conservative campaign promises, Carney noted that the BoE was conscious of the impact fiscal policy could have on economic growth. He added that the BoE would consider fiscal policy in confluence with its own policy measures.
The QIR showed that BoE’s Monetary Policy Committee cut its GDP growth forecast for the 2015 to 2.5% from 2.9% at the February report. The change in expectation largely being attributed to the drag of a persistently stronger Sterling and a softer outlook for house building and productivity. The QIR noted that while it could remain muted in the short term, inflation is likely to turn positive towards the end of the year as previous index declines (related to tumbling global energy prices) fall out of the annualised comparison period.
Official expectations are that in 2015 inflation will print +0.6%, but that in 2016 it will accelerate to +1.6%. As such the official forecast suggests that interest rate hikes in the UK will lift off in Q2 of 2016—three months later than the February report implied. Additionally the BoE’s mean estimate is that by the end of 2016 the benchmark rate will be +0.9%; implying 1, perhaps 2 rate hikes from the BoE in the second half of 2016.
Sterling’s post-election honeymoon period extended broadly into this past week. GBPUSD rallied up to its highest levels of 2015 earlier in the week as the dovish tone of the QIR was overlooked in favor of better than expected jobs data this week. In the last week or so this pair has advanced 6-cents from pre-election lows and 10-cents from the multi-year low touched mid-April.
Data showed that Wages Growth in the UK advanced, which is a key element to healthy inflation. Additionally it was revealed that the rate of unemployment in Britain declined to 5.5% in April, its lowest level since mid-2008. As we head into the weekend Cable has pulled back slightly, but is still on track to end the week comfortably higher. As the election glow looks to fade in coming weeks this pair could find itself retracing from current levels. However the overall outlook now compared to 2-weeks ago, before the surprise election results, is certainly less Sterling negative.
Sterling has also outperformed the common currency this week, though to a lesser degree than against Greenback following Carney’s specific mention of the pair during the QIR. GBPEUR drove towards 1.4000 in the first half of the week, however was turned back by resistance. Going forward, with the election related uncertainty out of the way this pair could quickly find itself resuming its previous upwards trajectory as the relative economic strength of the UK favors Sterling. 1.4000 is key psychological resistance, should it be breached it could clear a path to the 8-year high near 1.4250 established in March.
Looking ahead to next week two events worth keeping in mind are the April Consumer Price Index (CPI) numbers for Britain and the United States, on Tuesday and Friday respectively. CPI, which is the favored measure of inflation for both the BoE and Federal Reserve (Fed), has deteriorated in both areas over recent months. This has led both the central banks to soften their interest rate guidance.
The consensus forecast is that the British result will be an annualized 0.0% for the third consecutive month. Meaning that over the last year, ending in April, inflation in the United Kingdom has been flat. Given that the BoE maintains a +2.0% target, this is a disappointing expectation. Furthermore it suggests that interest rate guidance will remain dovish in the UK, as the argument for simulative policies (namely low interest rates) remains strong. Friday’s American number is expected to read similarly weak at +0.1% month-over-month in April, versus a +0.2 outcome last month. Once again the Fed maintains a target inflation level of +2.0%, implying that it is also in no rush to tighten monetary policy given the risks it might pose to the infant stage American economic recovery.
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