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UK Weekly Market Analysis
Sterling Craters on BoE’s Dovish Hike

David Starkey November 2, 2017

– USD stable on ‘all treat, no trick’ Fed

– Don’t be fooled by US nonfarm payrolls data

– Currencies look to Trump’s Twitter and Brexit negotiations for direction

 

As was widely expected, the Bank of England hiked its benchmark interest rate for the first time in 10 years this week. The move reverses the post-Brexit cut it rolled out in July 2016 and is driven by above-target inflation, which is a function of the post-Brexit sterling capitulation. Despite today’s hawkish move, the sentiment from the BoE appears to be that today’s action is ”enough for now.” According to fresh official projections, inflation is forecast to pull-back from current 3% levels in 2018. In line with this sentiment, a note about “potentially needing to hike more than the market expects” was removed from forward guidance, which is a signal the BoE views current financial conditions as fair. Furthermore, at the policy press conference, BoE Governor Carney struck a cautious tone, warning about the path of economic growth and the risks that Brexit poses.

Sterling gapped lower by about 1% in the aftermath of the BoE, effectively wiping out early week gains driven by speculators. Post-BoE action echoes the euro’s response to the ECB QE taper last week, and represents another “buy the rumour, sell the news” event. According to the BoE’s official forecasts, only 0.5% of further rate hikes can be expected by 2020. In contrast to the BoE, the Federal Reserve in the US projects 1.75% of rate hikes by the end of 2019.  As such, looking forward sterling could struggle to receive much in the way of support from monetary policy.

On the other side of the Atlantic, the world’s most important central bank sounded an optimistic economic note in its latest policy statement but stopped short of tightening monetary policy. The Fed acknowledged the American economy’s growing strength, observing that “the labor market has continued to strengthen and…economic activity has been rising at a solid rate.” The optimism was tempered by a cautious inflation outlook which emphasised that price growth continues to run a bit below target. Overall, the update proved to be as expected by markets. Accordingly, action in currencies, specifically USD, has been muted. Rather, greenback seems to be holding its breath for next month’s policy meeting where a pre-Christmas rate hike is now 90% priced in.

Heading into the weekend, all eyes will be on American nonfarm payrolls and average earnings data for September. Expectations are that earnings advanced +0.2% month-over-month, and about 310K new jobs are expected to have been created. If the forecast number of jobs is added, it would represent the strongest monthly gain since December of 2014. But don’t be deceived by the high headline number. Last month jobs actually shrunk by 33K due to recent hurricane activity in the southern part of the US. Accordingly, markets are looking for a strong rebound this month. In actual fact, if payrolls reads as expected, the two-month average is only 138K, which is well below the 2017 average of around 175K – not an especially strong signal for the US economy.

It has proven a very eventful couple of weeks in the world of currencies with lots of central bank action and key economic data releases. Next week, however, markets get a bit of a reprieve on that front. The economic calendar is fairly light, with British manufacturing production the headline event.

Despite the light data calendar, the risk of unexpected episodes of volatility remains high. Sources of market shocks next week will be the most likely come from newspaper headlines. Recurring themes like Brexit and Trump are strong candidates. Specifically for Trump, the special investigation into Russian election tampering, as well as hotly anticipated tax reform, are both approaching boiling point. Uncertainty in the political arena has previously to financial markets, USD included.

The UK and EU will meet at the back end of next week for another round of Brexit negotiations. Recent months have been characterised by deadlock as both sides have failed to find common ground on matters like the so-called “divorce bill.” As the deadline to the March 2019 exit date approaches, the urgency for the UK seems to be increasing. Talk of a no-deal outcome, which presents the greatest risk the UK economy and GBP, is growing ever more common.

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