Sterling rebounds strongly as Bank of England takes centre stage
03/Aug/2015 • Currency Updates•
Currency markets’ focus is shifting squarely towards pricing in the exact timing of interest rate hikes from the Federal Reserve and the Bank of England.
Last week it was the FOMC’s turn. It hinted at what it needs to see in the US economy before a rate hike, and that turned out not to be a high bar at just, “some further improvement in the labor market”. This means the absence of nasty surprises in the remaining payroll reports is enough to warrant the first interest rate hike in September, as we forecasted.
Expectations for Bank of England interest rate hikes are also being brought forward, and consequently last week we saw the US Dollar and Sterling outperform all other major currencies, rising particularly strongly against those originating from Europe.
All eyes are now on Thursday. The Bank of England will release its interest rate decision and, for the first time, will also publish the minutes and the quarterly Inflation Report all at the same time. This will no doubt be a volatile week in Sterling.
Last week we received another important datum that will no doubt help the Bank of England’s path towards hiking rates. UK GDP growth in the second quarter came out at a healthy 2.8% annualised, according to the first estimate. This marks a significant acceleration from the 1.6% pace in the first quarter.
The Bank of England is due to fully clarify its expected timetable for hikes on Thursday. While no one doubts rates will stay unchanged, the key will be the number of dissenters that vote for an immediate hike. We expect to see either three or four. Three dissents would put the MPC on course for a February hike. However, four dissenters would be a shock for markets, probably cause a sharp Sterling rally, and lead us to revise our Sterling forecasts and timetabled expectations for Bank of England rate hikes. Stay tuned!
Greece continues to fade from the headlines, and it appears the crisis had only a modest lasting impact on confidence across the rest of the Eurozone. The July composite PMI index of business confidence, published last week, pulled back about 0.5 to 53.7, to a level still consistent with modest growth in the 1.5-2% range.
Troubling signs emerged from the struggling Eurozone job market. Dismal figures in Italy meant that unemployment remained stuck at a sky-high 11.1% in June. The modest rebound in Italian employment seems to have petered out entirely over the last few months, a worrisome sign for the entire European periphery.
At any rate, macroeconomic news is taking a back seat to monetary policy developments, and the Euro traded downwards against both Sterling and the Dollar as the prospect of rate hikes in those countries firm up.
The key event for the Dollar last week was of course the July FOMC meeting and statement. Our take is that, while the FOMC has not quite decided to hike rates in September, the factors which may sway that decision do not require much improvement, simply, “some further improvement in the labor market”. We think this means essentially an absence of bad surprises. There are two labour market reports left between now and the September meeting and, absent a serious drop in job creation to a sub-150k level or less, we will have a hike in September. With weekly jobless claims printing consistently below 300k, we think that payroll prints above 200k are very likely, and therefore a hike is coming.
Other than the FOMC announcement, there were decidedly mixed macroeconomic news out of the US last week. GDP growth in the second quarter came out at 2.3%, and the first quarter figure was revised upwards sharply, from -0.2% to +0.6%. On the negative side, the Employment Cost Index (ECI) printed the smallest increase in labour costs for several decades, up just 0.2% for the second quarter. It is hard to tell how much this outlier will worry the Fed, but we think that headline job creation and monthly wage numbers are more important for now and so continue to expect a September interest rate hike.