"We Remain Cautious on Sterling" say UBS; Possibility Grows of Bank of England Actively Talking the British Pound Lower

As the British Pound continues to show strength on the global currency markets one analyst has warned that this strength, combined with elevated interest rates, will be a cause for concern over at the Bank of England.

Indeeed, Mansoor Mohi-uddin at UBS says the possibility of the Bank attempting to talk down Sterling has grown.

Until now, the central bank's new dovish communications framework has not proved effective; the 10-year government gilt has been on a rising curve ever since Carney advised that interest rates were on hold at least until the unemployment rate came down to 7%.

"We remain cautious on sterling" - UBS

Mohi-uddin says investors should be wary of the Pound Sterling for the following reasons:

• the majority of MPC members are worried that the current tightening in market conditions may smother the economic recovery. That may prompt officials to start talking down the pound or vote to re-start the BoE Asset Purchase Programme.
• the UK unemployment rate may stay at elevated levels even if the economy picks up if companies decide to boost output without hiring more labour. That would lead to a marked recovery in UK productivity growth.
• the latest MPC minutes show members have a range of views on whether productivity will revive and so keep unemployment from falling at a faster pace. But the BoE staff forecasts in the August Inflation Report envisage only a slow pace of decline in Britain's jobless rate over the next three years, and state the medium-term equilibrium rate of unemployment may be lower still at 6.5%.

"Thus even if the unemployment rate does fall towards 7.0% faster than the BoE currently forecasts, Carney has said it will not automatically 'trigger' interest rate hikes," says Mohi-uddin.

• the MPC sees the economy continuing to expand by 0.6%q/q in the second half of the year.

According to Mohi-uddin that modest pace of GDP growth is unlikely to absorb spare capacity rapidly:

"Thus the forward guidance knock-out clauses are unlikely to be triggered. As UBS Economics highlights, the conditions are not particularly binding anyway.

"For example, the MPC has almost never forecast inflation around 2.5% over an 18-24 month time horizon - despite actual inflation persistently overshooting its projections since the crisis started.

"In short, we think investors should remain cautious on sterling. If the BoE's forward guidance endures the currency will slide again particularly against the dollar."