At the August Inflation Report press conference, Governor Mark Carney and the MPC formally laid out the forward rate guidance for the Bank of England (BoE). ‘The MPC intends not to raise the Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%.
Mark Carney probably delivered quite close to expectations today. One could argue that the 7% threshold was a bit higher than expected and that the ‘knockouts’ were tougher than expected but still he basically promises to keep rates unchanged for three years compared with the less than two years expected in the money market. However, sterling still rallied today and EUR/GBP has fallen. Interest rates in the money market increased, especially two to three years out.
The question is why we have seen this GBP rally and whether a new trend is underway in sterling. In this respect, we would like to highlight the following.
1. The market is already heavily speculatively short GBP. We know from the so-called CFTC data that going into this meeting many speculative short GBP positions were in place. Hence, a lot of short covering is probably taking place right now. See the chart to the right for positioning. See also IMM Positioning: EUR/USD positioning approaching neutral again, 5 August.
2. The BoE and Carney did deliver a soft message today but expectations were also quite high ahead of the announcement. The market was probably ‘disappointed’ that there were no hints of further stimuli. The probability of new stimuli being added through new asset purchases actually fell today.
3. The recovery in the UK is well underway and the BoE actually revised its growth forecasts slightly higher. The latest key indicators such as PMIs have also been very strong. Hence, the rates and FX market simply do not believe the BoE and Carney when they say that rates will stay unchanged for three years. The BoE did not manage to convince the market of this today. The rates market still prices the first hike in the summer of 2015. The BoE says it will not happen before summer 2016 at the earliest.
Before today’s announcement, we had a 3M 0.88 forecast for EUR/GBP. Given the positioning unwinding currently in place and the slight disappointment in the news today, the risk is skewed towards further GBP strength short term and the risk of a more pronounced GBP sell-off should be much smaller now.
However, one important lesson from today is if GBP starts to appreciate markedly over the next year, e.g. if the strong UK numbers continue and rate hike expectations are fuelled, we believe it will be a temporary move. The clear conclusion from today is still that Carney has absolutely no plan to hike rates for the next three years. Rate hike expectations are in no way warranted by the BoE. In particular, if the recovery in the US and the eurozone continue, GBP will be left with the most aggressive and dovish G4 central bank after the Bank of Japan.
Read More: http://www.efxnews.com/story/20109/new-trend-sterling-underway-danske
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