Sterling soars to multiyear highs as Carney warns of hikes before year end
16/Jun/2014 • Currency Updates•
Bank of England Governor Carney lit up trading screens last week with his surprisingly hawkish Mansion House speech. He signalled that he has joined the more hawkish members of the MPC and now thinks that the rapid labour market tightening warrants hikes sooner than the market expects. Sterling rose sharply on the news against all major currencies, and broke through to fresh multiyear highs against the dollar and, particularly, against the euro, where it now sits at 18 month highs. Aside from the strength of sterling, we think that the continued erosion in the EUR/USD is significant and reflects increasing market realisation that the aggressive easing stance of the ECB is not compatible with the current levels of the common currency.
Beside the “Carney surprise” described above, last week we were treated to a rather enjoyable employment report out of the UK. Employment grew at a 4.6% annualised rate in the three months up until April, the fastest rate ever recorded. Unemployment is now at 6.4%. The only blemish in the report was continued stagnation in pay. Excluding bonuses, pay growth slowed down to 0.9% annualised rate, well below the rate of inflation. However, it appears that the Bank of England has chosen to focus more on fast-growing employment levels than in declining real pay.
A less-remarked but equally important aspect of Mr. Carney´s speech is the heightened level of alarm over the bubbliness of the UK housing market. The BoE thus joins the ECB and the IMF in explicit attempts to prevent monetary stimuli to a reactivation of the boom in housing prices.
Last week brought moderately positive economic developments out of the Eurozone. Industrial production rose a stronger-than-expected 0.8% in April, going some way to make up for the disappointment in first-quarter GDP figures. Unemployment news was mixed. Spanish employment levels have clearly stabilised and are showing signs of a bounce back (albeit from extremely depressed levels). Italian employment, however, continues to shrink and has yet to find a bottom. Now that ECB is set to ease aggressively, it would take a massive upside surprise in Eurozone data to reverse the depreciating trend in the euro, and we do not foresee any such development. We continue to expect a lower euro against all major currencies over the medium term.
The volatile May retail sales report undershot expectations last week. However, we do take comfort that April numbers were revised higher, and the more stable three-month core measure is still consistent with consumer demand growing above 5% annualised rate. All eyes now turn to the FOMC meeting next week. There is near unanimity that another $10 billion will be lopped off the monthly purchases of treasuries and mortgages. Far more interesting will be the publication of members’ expectations for growth and inflation, and the projected path for rate hikes in 2015 and beyond. We think that the expected path for unemployment will be revised down, and the timetable for hikes will be brought forward once again. This would be very good news for the dollar.