Markets Price in 2015 Interest Rate Hike

In the wake of yesterday's British pound rally Trading Central say they are forecasting more of the same today:

"Short positions below 0.8625 with targets at 0.8575 and 0.8555 in extension. Above 0.8625 look for further upside with 0.8645 and 0.8675 as targets. The pair is rebounding but stands below its resistance."

Geoffrey Yu at UBS says he believes the Euro rally is still intact:

"The cross came under sharp selling pressure and tested the support at 0.8584, but failed to close below it. With the bull trend intact potential is for a move above 0.8731 to test the critical resistance at 0.8815."

British Pound hogs the limelight / Factoring in a 2015 interest rate hike

The past 24 hours on the global currency markets have been dominated by the UK currency.

Yesterday's Bank of England Quarterly Inflation Statement was keenly watched with the outcome being a Bank of England that has changed strategy.

"The Bank of England followed in the footsteps of the Fed, as it linked its future monetary policy to the development of the unemployment rate. The Bank’s own forecasts imply the Bank rate will remain at its current levels for at least until mid-2016, while the clarified stance risks an increase in longer-term inflation expectations," says Jan von Gerich at Nordea Markets.

The idea that rates will be kept low until 2016 saw the Pound to Euro exchange rate initially slump; however this was followed by a sharp bounce as markets showed they believe rates will in fact rise before that:

"Clearly the market was positioned for something much more aggressive. In fact, the guidance came with so many caveats and knock-outs that many feel the BoE is actually looking at productivity more than anything; by keeping rates low, hopefully the trend in better data will continue and justify putting up rates by at least 2016," says Chris Weston at IG in Melbourne.

Geoffrey Yu, Strategist at UBS says the first wave of selling was quite straight-forward: "the BoE’s unemployment guidance pointed to a first hike around Q3 2016 – well beyond market pricing by as much as 12 months."

Markets then changed their minds as Yu explains:

"Profit-taking swiftly arrested the losses, but thereafter the currency started having second thoughts. The inflation and FPC conditionality ‘knock-out’ clauses sharply diminished the value of the guidance itself. Rates markets swiftly addressed this issue and ‘priced-out’ the 2016 guidance and sterling had to follow-suit."

von Gerich says he sees a rate hike almost a full year ahead of Bank of England guidance:

"After the recent batch of positive data, money markets price in the first rate hike in around mid-2015, i.e. much earlier than the BoE itself sees. Money market rates should thus have room to fall, but are unlikely to do so as long as strong UK data continue."

Turning to the outlook for the Pound Euro exchange rate the following factors must be noted:

• Unemployment figures will gain more attention - faster falls in unemployment will be see as pro-GBP
• Inflation numbers - Any spikes in inflation are pro-GBP
• With guidance now in play we suspect more attention will be paid to the relative economic fundamentals between the UK and Eurozone. Particularly the UK / Germany dynamic.