Sterling retreats after only one Bank of England hawk votes to raise rates
10/Aug/2015 • Currency Updates•
Sterling stole the spotlight last week amid an otherwise typically quiet August trading in currency markets. There was the release of the much anticipated, and simultaneous, Bank of England’s interest rate decision, meeting minutes, and Inflation Report. Overall, the tone was considerably softer than we and the markets had expected, with just one dissenter for higher rates out of the nine members. Sterling reacted badly, giving up all its gains for the week and ending lower against both the Dollar and the Euro.
The common currency, for its part, traded in a tight range around 1.09 vs the US Dollar, and the Greenback barely reacted to the July payroll report, which was squarely as expected and puts the Federal Reserve on track for a September interest rate hike.
In other G10 currencies, the most notable move was the very sharp rally in the Australian Dollar against every other major currency. The Reserve Bank of Australia seems to be toning down its dovish rhetoric on the currency and accepts that recent devaluation may have brought the currency back to reasonable long term levels.
The massive data release by the Bank of England on Thursday delivered a more dovish message than the market (and ourselves) had been expecting.
There was just one vote for higher rates, which came from long standing hawk McCafferty. Furthermore, no other hawks described their decision as “finely balanced” – as they had in July. This is a bit puzzling. Developments since July have mostly been positive: the Greek crisis has been resolved for now, and signals from the labour market in the UK have been bullish, with the gap between wages and core inflation at above 2% levels.
It seems MPC members are mostly relying on the strong Pound to do the tightening work normally carried out by rates, for now. But Sterling strength depends, to a large extent, on expectations for Bank of England rate hikes, and these expectations need to be validated at some point. That’s why we are keeping intact our call for a first UK hike in February next year, and from there a gradual strengthening of Sterling against the Euro.
Last week delivered some further disappointing data for the Eurozone economy.
Weakness in industrial production was evident in June’s lacklustre release. There were declines in Germany (down 1.4%), France (down 0.1%), and Italy (down 1.1%). These poor numbers do not bode well for next week’s key GDP growth flash estimates for the second quarter. Rather than the 2% we had been pencilling in, these are likely to come in closer to 1.5% for the Eurozone as a whole.
The sense of gloom was not helped by the June drop in retail sales, down 0.6% for the month on the back of bad German data. The fear that the Eurozone is incapable of maintaining even a modest 2% growth rate is likely to weigh on the Euro over the coming weeks and months and we expect the common currency to resume its downward path towards parity against the US Dollar.
The steady gains in employment seen in the July payroll report removed one of the two obstacles standing in the way of a September Federal Reserve interest rate hike – the other obstacle being the next report, due in the first week of September.
Net job creation in July was 215,000, and we saw a slight upward revision to the previous two months. Unemployment was steady, as was wage growth. The steady-as-she-goes outlook for the US economy received further support last week from the consumer sector, which saw stronger than expected vehicle sales in July.
Job growth of over 200,000 a month should be enough for those FOMC members willing to hike rates in September to achieve a majority and we continue to expect two hikes from the Fed before year end.