Sterling, UK bonds may catch up with recovery
By Anirban Nag, ReutersLONDON -- Recent forecast-busting UK economic numbers have had a muted impact on the currency and bond markets, but that is likely to change now the Bank of England has tied its “forward guidance” on interest rates to unemployment.
August 12, 2013, 11:00 am TWN
After improving data such as July's jump in services sector activity and a steady rise in house prices, further improvements, which many anticipate, could see sterling rise and bonds fall, as markets price in rate hikes sooner than previously. That in turn could weigh on UK stocks, analysts say.
The major driver for much of this year has been expectations that the BOE under new governor Mark Carney would issue unprecedented guidance that interest rates would stay low.
That goes a long way to explaining why the pound is 4 percent lower against the dollar at US$1.5525 and down 5.6 percent against the euro. Low interest rates make a currency less attractive and keep bond yields anchored.
On Wednesday, Carney said rates would stay at record low levels of 0.5 percent until the jobless rate fell to 7 percent from the current 7.8 percent — a process he said could take three years.
“It was quite liberating that the subject of forward guidance has now been dealt with,” said Lutz Karpowitz, currency strategist at Commerzbank. “Sterling is now likely to benefit from positive macro data in the future.”
Much to the disappointment of many in the bond market and those positioned for a weaker pound, Carney did not pledge to keep rates low for a specific period. Instead he surprised markets by introducing what analysts called “knockout clauses.”
He said the BOE would consider raising rates if its forecasts showed inflation at 2.5 percent or more in 18-24 months, if low rates threatened financial stability, or if medium-term inflation expectations rose significantly.
This will put the focus squarely on economic data.
Testing the Theory
A raft of UK indicators, from consumer prices and retail sales for July to the monthly jobs report, will test this theory in the coming week.
UK unemployment for June is forecast to remain steady at 7.8 percent. But with the economy recovering, some say the jobless rate could drop to 7 percent sooner than Carney suggested.
“Unemployment may be well clear of the current threshold, but as it gets closer to that level, the risk of higher rates at some point will increase,” said Adam Cole, head of currency strategy at RBC Capital Markets.