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Sterling-Bulls Relief as Saunders Maintains Line that U.K. Interest Rates Must Rise

Michael saudners

Image © Bank of England

The British Pound took a battering at the hands of Bank of England Governor Mark Carney overnight, confirming that Bank of England interest rate expectations remain a key driver of Sterling.

Carney told the BBC that he believes while an interest rate rise is likely in 2018, the exact timing is up for debate which quickly crushed market expectations for a May rate rise. The Pound has traded higher for much of April on the steadfast assumption that a rate rise was coming in May; Carney's words cast serious doubt on such a move and almost certainly kick a second interest rate rise for 2018 into the long grass.

In light of recent developments, today’s focus for the Pound is on a speech by Michael Saunders delivered in Glasgow, the full text was released at 10:30 and can be downloaded here.

Bank of England Monetary Policy Committee member Michael Saunders - a proponent of higher interest rates at the Bank - has maintained his position on the need for higher rates according to the contents of the speech, which should ease some of the pressure being placed on Sterling.

Saunders notes:

  1. Slack in the UK economy is limited - sees greater capacity pressures
  2. Any tightening will be gradual, but not "glacial"
  3. The economic slowdown seen in the first quarter is questionable and may be temporary.
  4. Says the UK economy doesn't need as much stimulus as it is currently enjoying

At the last MPC meeting in March Saunders was one of two members of the Committee who voted for an immediate hike in interest rates.

Saunders appears to have suggested to markets that Carney's Sterling-negative comments issued in Washington do not necessarily mean a May rate rise is dead.

"'gradual' does not necessarily mean that the exact timing of rate changes must be totally predictable or signalled in advance. The MPC does not intend to create unnecessary uncertainty, and gives guidance – based on our economic forecasts – on the expected general outlook for interest rates. But I doubt that we will regularly use code words to effectively pre-announce policy decisions from meeting to meeting."

Indeed, Sterling-bulls appear to have taken heart from the MPC member's comments.

"Saunders keeps all options on the table over future BoE policy normalisation paths (prudent approach). Will keep markets at 50:50 over a May rate hike. If you believe that nothing has changed this week (like we do) then GBP has tactical upside ahead of May meeting," says Viraj Patel, a currency strategist with ING Bank N.V. in London. "The point he's trying to make is that if this is a 'genuine' BoE normalisation cycle, then it won't just be constant 'one-off' moves. Expect some upward trajectory in UK rates & a steeper curve supports GBP."

In the wake of the speech, the GBP/EUR exchange rate was quoted at 1.1416, having been as low as 1.1372 today.

The GBP/USD exchange rate is quoted at 1.4056, having been as low as 1.4036.

The propensity to raise interest rates at the Bank, despite recent soft data is indeed there and there is a sense in some corners that the Bank can raise rates without hitting economic activity.

Indeed, the longer policy remains overly generous, the more the risks of an asset bubble of some sort building increases.

Studies conducted by Athanasios Vamvakidis on the Global Rates & Currencies Research desk at Bank of America Merrill Lynch on the current state of the UK economy relative to interest rate settings, show "that global monetary policies remain very loose, despite hikes/less loosening; the BoE and Riksbank are the two G10 central banks with, by far, the loosest monetary policies and therefore the most room to tighten."

Taylor rule monetary policy settings

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