Pound Recovers as Bank of England's Forbes Breaks Rank on Interest Rate Call

Pound Sterling recovered against the Euro, US Dollar and other majors through the mid-week session after some surprising comments made by a member of the Bank of England’s key decision-making Monetary Policy Committee.

External Member of the MPC, Kristin Forbes, appears to be at odds with her peers at the Bank saying in a speech that she believes an interest rate rise at the Bank could soon be warranted.

The call comes just days after the British Pound slumped as the MPC voted 9-0 to keep rates unchanged while at the same time suggesting no rates were foreseeable over coming months.

"Although she is widely viewed as one of the most hawkish members of the central bank and her views diverge with Governor Carney's cautious outlook, they were enough to turn the Pound around, driving Sterling sharply higher against all of the major currencies," says Kathy Lien, Director at BK Asset Management in New York.

Forbes believes there is too much easy money in the UK economy which is performing well, and this could well overcook prices in the future.

“If these trends in both the real and nominal data are solidified, it will become increasingly difficult for me to justify tolerating such a large and likely overshoot of inflation - especially when compared to such a small and uncertain softening in growth and unemployment,” says Forbes.

It is argued by Forbes that the risks of an immediate interest rate rise are negligible given today’s extremely low interest rates at the Bank.

She believes the substantial amount of monetary stimulus that is already in place through a variety of programmes would still leave a substantial amount of monetary support for the economy.

“If the real economy remains solid and the pickup in the nominal data continues, this could soon suggest an increase in Bank Rate,” says Forbes.

Don't be Scared of Uncertainty

Forbes argues that the impact of uncertainty caused by the Brexit referendum has been vastly over-exaggerated, and a major slowdown resulting from Brexit may actually never come.

Her analysis of the post-referendum UK economy is that economists greatly miscalculated the negative impact that uncertainty over Brexit would have on investment decisions and consumption.

Her argument suggests that uncertainty only has a material negative impact on economic activity if accompanied by restrictions in lending in the economy, as was the case in the 2008 financial crisis.

The Brexit vote is no crisis of monetary supply and therefore the economy has performed well.

Rather, there are heightened risks of waiting too long before acting.

“Improved inflation data across the world has raised suspicions that we could see the likes of the ECB and BoE tout a more hawkish tone. Today's comments stand in stark contrast to the accommodative stance preferred across Europe as a means to ward against any adverse economic effects of the Brexit process,” says Joshua Mahony at IG in London.

If we consider the most recent bout of Sterling weakness has its roots in the Bank communicating that rate rises are some way off on Thursday February 2, then this row-back by a leading MPC member is significant.

Indeed, there are even suggestions that the Bank is using a strategy of talking down the Pound to help improve the UK's global trading position.

If this view from Pimco's Joachim Fels is correct, then the bar for a more hawkish slant at the Bank of England and a stronger Pound is considerably lower than we originally thought.

The Pound to Dollar exchange rate recovered its hefty losses as a result and is quoted at 1.2518 at the time of writing (Wednesday morning update) having hit a low of 1.2346 on Tuesday January 8.

The Pound to Euro exchange rate also advanced and reached 1.1730 having been as low as 1.1573 the day before.

Pound is Skittish

The rebound in Sterling following Forbes' comments was notable but there remains concerns that the market is particularly short of liquidity at the current time.

When market liquidity is low moves can often be exagerated, therefore we remain wary of Sterling's prospects moving forward.

"After pushing down to 1.2350/45, on the break of 1.2450/1.2350 support, prices staged a dramatic recovery in late afternoon and evening trade. This highlights the illiquid and skittish nature of the market at the moment and the dangers of price action at the mid-points of ranges," says analyst Robin Wilkin at Lloyds Bank.

With US yields holding their range supports Wilkin believes we could see a little support for the USD in general today and this rate drifting sideways/lower again, leaving potential GBP outperformance shown in the crosses.

However, against the Euro, Wilkin is more constructive saying he retains a bearish bias on the shared currency.