LONDON Feb 12 Sterling surged on Wednesday as
money markets moved to factor in a UK interest rate rise earlier
in 2015 than previously thought after the Bank of England upped
its economic forecast and pushed up expectations of a rate hike
The bank, struggling to manage market thinking on rates
after unemployment fell far more sharply last year than it had
expected, raised its forecast for economic growth this year to
3.4 percent from 2.8 percent.
It also said market pricing calling for the first tightening
of policy in five years in the second quarter of next year were
consistent with keeping inflation on target, prompting a half
percent jump in sterling against the dollar.
"The one hawkish element of the (report) ... is that this is
basically a blueprint ... as to how the BoE expects to tighten
monetary policy," said Stephen Gallo, FX strategist at BMO
Capital Markets. "That's sterling supportive."
The pound rose 0.8 percent - its biggest gain in three
months - to a two-week high of $1.6589.
The euro, weakened by talk of a negative deposit rate at the
European Central Bank, tumbled 1.2 percent to 81.90 pence
. That provided a welcome profit for hedge funds who
have switched their sterling bets from being against the dollar
to against the single currency.
The March long gilt future was down 82 ticks at
109.32. Dealers said some players were caught out betting on a
stronger rebuttal of market rate expectations by the bank, which
had been anxious to stress it would stay on hold for as long as
possible to allow Britain's economic recovery to bed in.
Strategists said there was a clear shift in the consensus
over the path of policy over the next two years.
Philip Tyson, a rate strategist with ICAP in London, said
implied forward interest rates show a quarter point rise is
fully priced in by parliamentary elections in May of next year,
followed by another 100 basis points by August of 2016. This
morning those rates had pointed to similar rises being delivered
only by the end of 2016.
Short sterling interest rate futures - which reflect bets on
market rather than actual policy rates - fully priced in a 25
basis point rise in three-month sterling deposit rates in March
2015 and show a substantial chance of a rise by December.
"Carney's reference to interest rates being at 2 percent in
three years' time marks a sea-change in policy," said Trevor
Welsh, Head of UK Sovereign and Inflation at Aviva Investors.
"Effectively, the Bank of England is now looking at a time
well within its forecast horizon when emergency interest rates
will no longer be necessary."
Sterling was the best performer among major currencies in
the second half of 2013 on the back of forecasts that the Bank
of England would be the first of the developed world's central
banks to lift rates after five years of ultra-loose policy.
But Carney and other officials have worked hard to talk down
those bets, concerned that Britain's recovery is still based
largely on consumer credit and house price rises in some cities
while real wages and business investment continue to fall.
Britain's next parliamentary elections are set for May next
year. Finance minister George Osborne has promised to stick to a
course of fiscal tightening which calls for the BoE to keep
interest rates for business as low as possible.
In a news conference after the report's release, Carney,
head-hunted by Osborne for the bank, offered numerous notes of
caution on the economic outlook, ranging from a strong pound's
impact on exporters to a warning that headwinds would persist.
Not everyone thought Wednesday's rise in the pound was
justified by Carney's comments.
"We think this probably presents a good opportunity to go
short cable (the sterling-dollar exchange rate)," said Alex
Edwards, London-based Manager of Corporate Business at USForex,
pointing to Fed chair Janet Yellen's comments on Tuesday that
the central bank was on track to keep reducing its stimulus.
And Lee McDarby, executive director, corporate FX sales at
Nomura International, said sterling's spike was an
"It has taken a long time for the UK to be able to take
advantage of the relatively weak pound for exporters and it
would seem that the Bank of England is very conscious not to
allow sterling to get too strong," he said.