British Pound Edges Higher after BoE's Carney Keeps Hopes of an August Rate Hike Alive

- GBP rises as BoE's Carney gears up for Newcastle speech.

- Recent data suggests UK economy recovering from Q1 lull.

- Markets look to Carney for encouragement of an August hike.

(C) Pound Sterling Live

The Pound edged higher against most developed world rivals Thursday as markets responded to a speech from Bank of England governor Mark Carney that did little to discourage markets from betting the Monetary Policy Committee will raise interest rates on August 02 after its next meeting. 

Governor Carney told an audience in Newcastle, England the economic slowdown that gripped the UK in the first-quarter was due largely to poor weather and not the economic climate, citing "a number of indicators" to have shown household sentiment and spending rebounding "strongly" of late. 

This is an important remark from the Bank of England's most senior policy maker as weaker economic growth was one of two reasons behind why the MPC eschewed an interest rate rise, which markets had come to take for granted, back in May. That decision dealt a blow to Sterling, which now trades at a 2018 loss against the Dollar after previously having risen as much as 6%. 

"A number of indicators of household spending and sentiment have bounced back strongly from what increasingly appears to have been erratic weakness in Q1. The UK labour market has remained strong, and there is widespread evidence that slack is largely used up. Pay and domestic cost growth have continued to firm broadly as expected. Headline inflation is still expected to rise in the short term because of higher energy prices," Carney says, from Newcastle.

With less than a month to go before the August BoE meeting, markets had viewed Thursday's speech as providing the governor with one of only a few remaining opportunities to validate or discourage recent speculation the Bank will go ahead and raise rates next month.

"Carney is clearly shifting from 'hold' to 'hawk', it's helping GBP," says Neil Jones, a dealer with Mizuho Bank Ltd. "Good chance Carney votes for a hike in August, judging by the Newcastle speech today. Certainly GBP turned from looking toppish to catching a rally on the back of it."

The remarks come after this week's series of IHS Markit PMI surveys which showed activity in the UK manufacturing, construction and services industries regaining momentum following a weak start to the year. 

Notably, UK services companies saw business activity rise at the fastest pace for eight months during June, giving rise to a flood of new work that saw order books swell at their fastest pace since May 2017. 

"The release yesterday of the latest UK services PMI for June provided another encouraging signal that economic growth is rebounding," says Lee Hardman, a currency analyst at MUFG. "There has been a marked improvement after confidence hit a low of 51.7 in March, which fuelled pessimism that the UK economy was finally starting to slow more sharply in repose to Brexit uncertainty."

Hardman says the services data means it is now "understandable" that the market is becoming more confident the BoE will raise rates in August and that he was looking to the Newcastle speech for a signal that Carney is comfortable with rising rate hike expectations. 

The services industry is the UK's largest economic sector so the PMI data is closely watched by markets. 

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Inflation Outlook is Key to Interest Rates and GBP

While a softer economy was one of the reasons given by the BoE for having eschewed a rate rise back in May, it was not the only one, as a steeper than expected fall in UK inflation has also stayed the Bank's hand.

Earlier forecasts suggested UK inflation would remain above the 2% target until at least the end of the first-quarter 2021, which led Carney to warn in February the BoE could raise rates faster and further than markets expected if its predictions were validated. But since then inflation has fallen from 3% to 2.4% and now sits within touching distance of the target.

The BoE said in May that inflation was no longer expected to sit above the target level at the end of its forecast period and that, instead, it would sit exactly on-target by this time, which suggests the Bank's inflation mission has been accomplished. Carney reiterated the former view during his speech in Newcastle. 

"Overall, recent domestic data suggest the economy is evolving largely in line with the May Inflation Report projections, which see demand growing at rates slightly above those of supply and domestic cost pressures building. The MPC will continue to monitor incoming data and review prospects for growth and inflation in the UK in order to set monetary policy consistent with returning inflation sustainably to target," Carney said Thursday. 

Changes in interest rates, or hints of them being in the cards, are only made in response to changes in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators. 

"The August meeting is a very close call - and comments from Mark Carney in a speech in Newcastle today could alter the balance - but as things stand, we still think that the activity data will give the Committee reason to doubt that the economy warrants another rate hike next month," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

Puzzling Over Haldane 

The decision to eschew a rate hike in May left markets looking to the August meeting for the next possible move. Since then the Bank of England's chief economist, Andy Haldane, has joined two other MPC colleagues in voting for a hike.

"I would have voted to raise Bank Rate at the MPC’s May meeting had data on the economy held firm. What we saw ahead of that meeting was a string of weak data suggesting consumer spending might be faltering," Haldane said in a speech at the end of June. "I believed there was option value in waiting to see if these data signalled the start of a lasting retrenchment by households, or were instead a temporary snow or statistical blip."

Analysts are still attempting to fathom whether Haldane has gone over to the hawkish side in order to maintain balance and consistency in voting, given Ian McCafferty departs the MPC at the end of August, or if he genuinely believes a rate rise is merited.

"His successor Jonathan Haskel has so far not stood out as a hawk but like the majority tends towards unchanged interest rates. So it is possible that Haldane has joined the hawks in the knowledge that Haskel will not take McCafferty’s hawkish approach. That would mean that after McCafferty’s departure the proportion of votes would remain 7:2 and not turn out to be 8:1. The latter would constitute a dovish signal for the market, says Antje Praefcke, an analyst at Commerzbank. 

Sterling-Overnight-Index-Average pricing on the morning of Thursday 05 July implied and August 02 Bank Rate of 0.62%, up from 0.59% before the services data were released.

Many say that current SONIA pricing suggests around a 70% probability of a rate hike in August but if markets were as confident in the likelihood of a rate rise as Andy Haldane appears to be in the merits of one, then that implied rate would be closer to the 0.75% Bank Rate that would prevail if the BoE actually pulls the trigger.

If and when financial markets become more willing to bet on an August interest rate rise then this implied rate will rise further, and the Pound with it.

The Pound was quoted 0.13% higher at 1.3245 against the Dollar after the speech Thursday while the Pound-to-Euro rate pared losses to trade just 0.10% lower at 1.1333. Sterling was also higher against the Japanese Yen, Swiss Franc and Canadian Dollar but lower relative to all other developed world currencies.

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