Dovish Inflation Report hits Sterling; Bank of England hikes pushed into 2015
18/Aug/2014 • Currency Updates•
The pound saw the only significant move among the major currencies last week. The quarterly Inflation Report validated our view that the Bank of England is increasingly shifting its focus from improving unemployment to stagnant wages. Markets were obviously surprised, as this seems to rule out any hikes in Q4 2014, again in line with our expectations. Sterling was sold heavily against other major currencies. Not even the release of (once again) dismal economic data in the Eurozone was enough to help sterling, which ended the week down nearly 0.5% against the common currency.
Markets were obviously blindsided by the Inflation Report released last week. The MPC revised sharply down its expectations for wage growth in the remainder of 2014, to barely above 1%. It had little choice given the stagnation and outright decreases in nominal pay we saw in last week’s labour market report. It also brought down its estimate of how low unemployment can go before inflation pressures start to accelerate – the so-called non-accelerating inflation rate of unemployment, or NAIRU. This is now 5.5%, down from 6-6.5%. Finally, the estimate for 2016 inflation is now slightly below the 2% target. Taken together, these revisions seem to rule out any hikes until 2015. This had been our central expectation, but not the market’s. Sterling was inevitably hit as investors pushed the timetable for BoE hikes further into the future.
Last week’s Eurozone GDP growth of barely 0.2% QoQ (amounting to de facto stagnation) failed to match even the much-lowered consensus expectations. These had been brought down following negative surprises from Germany and Italy the previous week, but not fast enough. These numbers not only add to the gloom surrounding the European economy; they also call into question the usefulness of the PMI business surveys, as the gap between the relatively optimistic levels in the PMI and actual economic data shows no sign of closing.
We expect the ECB to react to this data and announce further monetary easing measures at its September meeting. Among the possibilities: another (small) cut in rates, the launching of the ABS program addressed to SMEs, or outright purchases of sovereign bonds in the market.
Mixed-to-positive news out of the US last week. Retail sales in July were disappointing, stalling to a barely positive 0.1%. This is a significant reduction from the nearly 0.5% monthly pace over the previous quarter. On the other hand, the JOLTS labour survey showed that the upswing in unfilled job openings is intact, rising from 2.9% of the labour force to 3.3%. The FOMC has signalled that it pays close attention to this gauge of tightness in the labour market. Rounding up a week of mostly second-tier reports, manufacturing grew a sharp 1% in July, considerably above expectations. Taken together, last week’s data is still consistent with 3Q growth in the range of 3-3.5%; a sharp contrast to the permanent stagnation that seems to have settled in across the Atlantic.