In my note last month I finished off by saying ‘’ Mark Carney may have to delve deeper into his unconventional toolkit to get significant Stg weakness (above .8800)’’.
In the event he did just that and came up with ‘’Forward Guidance’’ (this is the communication by a central bank aimed at signalling the likely future path of monetary policy), the market as is its wont anticipated this and aggressively sold Stg in advance of Mr Carney’s announcement. Eur/Gbp was trading at .8700 & Stg/Usd (the Cable) on a1.5200 handle prior to the announcement. All of this despite a slew of good economic releases in the ten days before Mr Carney’s speech.
The Bank of England announced forward guidance at the same time as the release of the Bank’s inflation report. The Bank assured its faithful followers otherwise know as Stg bears that interest rates would not be raised until unemployment reached 7%, the Bank’s report expects it to hit this target some time around Q3 2016. However that was not all, Mr Carney & his committee allowed themselves wriggle room, while attempting to preserve their rather tattered reputation as inflation fighters by adding some caveats – they could raise rates if (a) their projections showed inflation exceeding 2.5% eighteen to twenty four months forward (b) that monetary policy poses a threat to fiscal stability.
Sterling’s reaction was predictable; after an initial knee jerk sell off to 1.5205, the Cable jumped more than three cents to a high of 1.5530 while Gbp against the Eur was initially sold to .8730 by some excitable Sterling bears it soon was testing .8600 as it dawned on these same bears that the Bank’s record in controlling and forecasting inflation leaves a lot to be desired. It does not take a very vivid imagination to envisage a scenario where the Bank would have to tighten policy (withdraw stimulus or raise rates) to control inflation.
So what have we learnt?Well the first thing is that the UK monthly unemployment levels are going to be very important as are the UK inflation releases. It so happens that we get the unemployment rate tomorrow, it is currently at 7.8% and the market expects an unchanged reading.
As mentioned earlier the economic releases of late have beaten expectations, there is a recovery underway in the UK, will that recovery be reflected in the jobs market and will it lead to higher inflation? Conventional wisdom says that there is a lot of spare capacity in the UK economy so we may see the unemployment level come down slowly, it is easy to buy into this viewpoint. However I think when it comes to inflation, the Bank of England is asking the market to suspend a well honed scepticism if they think we can have a UK recovery without inflation.
What does all of this mean for Stg?As I write we are trading just over .8600 with rallies to .8620 getting sold into while there are good bids at .8580. Cable is ranging between 1.5460 & 1.5500. It is my view that in the short term (until end of September) we have probably seen the top of the Eur/Gbp (.8730) and I see a slow test lower to .8500 ahead of .8450. Cable with its dollar leg is more difficult to call, sustained dollar weakness as a result of delayed tapering could see it testing strong resistance at the 1.5750 level. This level should be attractive to importers who prudentially would have set budget levels closer to 1.5000 while any pull back to 1.5350 now should find a slew of buyers.
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