Sterling soars as Bank of England signals hikes coming in 2015
16/Feb/2015 • Currency Updates•
Sterling stole the spotlight last week in currency trading. The Bank of England’s quarterly Inflation Report openly welcomed the recent drop in oil prices, and, in line with our forecasts, hinted that interest rate markets were mistaken in ruling out a 2015 rate hike. Unsurprisingly, the Pound soared against its peers, ending the week well up on its recent lows against the Dollar and at a new multiyear record high against the Euro. The latter saw another week of stabilisation and even managed to stage a modest rebound, as hints begin to emerge that an agreement between Eurozone authorities and the new Greek Government may be reached as early as Monday.
In other notable FX news, the Swedish Krona suffered as the Riksbank became the latest central bank to shock markets, announcing negative rates and the beginning of quantitative easing at its meeting last week.
News in the UK was dominated by the surprisingly (for many) hawkish quarterly Inflation Report published by the Bank of England last week. Growth forecasts were revised upwards, while wages are expected to grow by as much as 3.5% this year. The Bank’s estimate of remaining slack in the economy was revised down to 0.5% from 1% of GDP. Although inflation will be pushed to zero and possibly into negative in the second and third quarters, Governor Carney expects the 2% target to be reached in the medium term; he referred to the “unambiguously net positive effect” of lower oil prices, clearly discounting any risk of deflationary expectations taking hold in the UK. The Pound reacted with a sharp rally against all other major currencies, as markets quickly brought forward their expectations of interest rate hikes in the UK – though not quite enough, in our view, which still calls for a first hike sometime in the last quarter of this year.
The string of modestly positive surprises from the Eurozone economy continued last week. GDP growth in the fourth quarter came out at a higher-than-expected 1.4%. Not quite sufficient to make a significant dent on the level of unemployment, but an acceleration from the previous quarter’s dismal 0.6% level. An upside surprise in German growth, which accelerated to 2.8%, was the main reason. The Eurozone economy is now benefitting from three distinct tail winds. First, the massive depreciation of the currency, which boosts the export sector. Second, the drop in energy prices, which increases real incomes in a continent that imports essentially all of its oil. Finally, the ECB-engineered drop in interest rates, which lifts pressure on highly indebted countries and seems to be finally filtering through to loan demand.
Of course, the short-term outlook of the Euro will be driven mostly by dramatic headlines about the negotiation between the new Greek Government and Eurozone officials. We remain optimistic that it is in both sides’ interest to reach a face saving agreement. This will allow the Greeks to focus scarce political capital on domestic reforms, and the Eurozone to avoid another financial accident just as macroeconomic prospects begin to brighten. Some tentative signs have emerged that this is happening over the past 48 hours. However, it seems clear that all negotiations will come down to the wire and we expect no news before late on Monday evening, at the earliest.
The news out of the US last week was disappointing, and somewhat puzzling in view of the undeniable strength in the labour market. Retail sales disappointed for the second month in a row, falling 0.8% overall in January, rising just 0.1% excluding volatile gasoline and automobile sales. By contrast, the JOLTS labour market survey was consistent with a further tightening of the US jobs market, with the number of work openings relative to the size of the workforce up again to the highest level since 2001 and close to an all-time record. We will wait for clarification between these two diverging trends before revising downwards our estimates for US growth, but it seems clear that the gap in economic performance across the Atlantic has stopped widening for now.