After almost 7 weeks of somewhat tedious sideways trading on Sterling/Dollar, yesterday there was finally signs of life. An intraday breakout on Cable above $1.5690 resistance seemed to be suggesting finally some upward traction on the pair. So what was the driver? Well, the Bank of England seems to be positioning itself increasingly for tightening and is watching some key economic data which could usher a change of stance on the Monetary Policy Committee (MPC). Yesterday, inflation ticked higher. This could be the beginning of the move that determines when the Bank of England will raise interest rates.
For several months there has been considerable debate over the exact timing of when two of the world’s major central banks will begin to tighten monetary policy and raise interest rates. The Federal Reserve could move maybe as soon as September, however the Bank of England does not appear to be too far behind.
At the weekend, one of the Bank of England’s monetary policy decision makers sitting on the MPC gave a considerable hint that she was close to starting to vote for an increase in interest rates. Kristin Forbes wrote an op-ed in a UK newspaper. She gave a balanced argument over the potential for interest rate movements in the UK.
On the dovish side, she suggests that if rates were to be raised too early then it could moderate companies’ willingness to invest and also impact on consumer spending. Furthermore, the recent devaluation of the Chinese yuan is likely to mean there is more time before the inflationary pressures build up in the UK. The China point is a look at the external factors on UK CPI, but these are to a certain expect reduced by looking at core CPI.
From a hawkish perspective, Forbes was more animated, suggesting that keeping a lid on inflation was similar to preventing sunburn. She also believes that it can take up to 2 years for a rate rise to fully filter through into the economy. So to avoid the sunburn setting in, measures need to be taken that prevent it setting in before you see the negative effects, you need to prepare early otherwise it could be too late. She is alluding to the fact that the UK needs to start normalizing monetary policy before it is too late. She also says that keeping rates at record lows despite the economy growing at pre-crisis trends threaten to undermine the economic recovery. Forbes expects CPI to stay around flat before picking up in 2016, which would suggest that she sees a need to start voting for a rate hike in the coming months.
Yesterday we saw the headline CPI increase from 0.0% to +0.1%. No much I hear you say. However, the core CPI which strips out volatile food and energy costs increased from +0.8% to +1.2% and was way ahead of the +0.9% that had been expected by the consensus. Although the imported effects of falling commodity/energy prices continues to keep an anchor on headline CPI, the core inflation is rising. This could usher the likes of Kristin Forbes to move sooner rather than later.
As part of the Bank of England’s “Super Thursday” we found out that Forbes was one of 8 members of the MPC to vote to hold rates at 0.5%. The one dissenting voice was Ian McCafferty – and he is not even historically the most hawkish member of the committee (that award would usually reside with Martin Weale). That means that we could see perhaps 3 members voting for a rate hike in the next couple of months. Mark Carney’s recent rhetoric suggests that he is in the same sort of camp that Forbes is in, recently saying “The decision as to when to start such a process of adjustment will probably come into sharper relief around the turn of this year”. MPC member Minouche Shafik, who describes herself to be an “owl” (i.e. “look at the data and try to be wise”), is also said to be very close to Mark Carney’s position on rates too. That would make 5 of the 9 and conditions are set for a move on rates.
If Forbes and Carney are correct and inflation does start to consistently tick higher around the turn of the year, then this makes it increasingly likely that we will see a rate hike in February. This would coincide with the first Quarterly Inflation Report of 2016 and the Bank would have a whole new batch of economic projections with which to make its argument.
The price of Short Sterling Interest Rate futures suggests that the market is now positioning for a Q1 2016 hike too. It seems as though if economic trends progress as they are, the stars are aligning for February.
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