LONDON (Reuters) - Britain’s pound topped $1.34 for the first time in a year on Thursday, after the Bank of England warned it might raise interest rates for the first time in a decade in the “coming months”.
Sterling initially dipped on the publication of the Bank’s policy decision, as markets reacted to the fact that only two BoE policymakers had voted for an immediate rate hike. There had been some talk beforehand that another rate-setter could shift to that more hawkish camp.
But it quickly reversed course to turn higher on the day as investors digested the Bank’s statement and brought forward their bets on when the BoE will raise rates.
On a trade-weighted basis, sterling was on track for its best week in over two years, after a 2.4 percent climb.
Six-month Sterling Overnight Index Average (SONIA) swap rates, which reflect market expectations for interest rates, hit their highest since June 24, 2016, the day of the Brexit vote result, at 32.20 basis points.
“After recent warnings that markets were under-priced for potential interest rate hikes, the MPC appears close to following through and tightening its policy in response to above-target inflation,” said Timothy Graf, head of macro strategy for EMEA at State Street Global Markets.
Data earlier this week showed inflation spiked to 2.9 percent in August, its highest level in more than five years and well above the BoE’s 2 percent target.
But the Bank faces the dilemma of having to balance that with still-weak wage growth, slower economic activity this year and big questions about what Brexit will mean for the economy.
The BoE said the economy was doing a little better than it had expected last month, and that inflation was likely to exceed 3 percent in October - slightly above previous forecasts.
After dipping to $1.3148 initially, sterling jumped as high as $1.3353, up a cent and a half from where it had been trading before the release of the policy decision.
Comments from BoE Governor Mark Carney later in the day gave sterling an additional boost, pushing the currency as high as $1.3404. That was its highest since September 2016.
Against the euro, the pound gained over 1 percent on the day to hit 88.69 pence, its strongest since July 20. That puts it on track for its strongest week against the single currency since November.
“Clearly the Bank isn’t overly concerned about yesterday’s poor wage growth data, and sees the UK economy picking up more quickly than expected,” said Hamish Muress, currency analyst at OFX.
“The market favours today’s hawkish stance, and the pound (is) rallying against the dollar in anticipation of a coming rate rise.”
British government bonds took a beating from rate-hike jitters.
The 10-year gilt yield jumped over 9 basis points to 1.23 percent, the highest level in six weeks. Gilt futures were down 68 ticks at 125.42, having traded at 126.17 just before the rate decision.
The two-year gilt yield was up almost 10 basis points on the day at 0.39 percent, its highest since late June.
Britain’s FTSE 100 turned lower after the policy decision. It closed down 1.1 percent on the day.
“The BoE have been here before in terms of warning explicitly about the risks of earlier hikes that the market had been anticipating only for those expectations to be unfulfilled,” said CIBC World Markets currency strategist Jeremy Stretch.
“The market pricing in early action in November or in February may also prove to be perhaps a little disappointing this time around.”
Additional reporting by Helen Reid and Dhara Ranasinghe; Editing by Larry King