Home » Business » A rate rise conundrum despite sterling surge against dollar
Business

A rate rise conundrum despite sterling surge against dollar

The pound may have been the worst performing major currency of recent times, but during the last three months it has been on an absolute tear.

Having traded as low as $1.2587 as recently as 21 June, it hit $1.3615 earlier on Friday, a gain of 8%.

The pound is now trading against the greenback at levels last seen in the immediate aftermath of the vote to leave the EU in June last year.

That may not sound like much, given that the pound was trading at $1.50 before news of the Leave vote came through, but it does represent a significant recovery given that, around the time of the ‘flash crash’ on 7 October last year, some wild-eyed souls in the currency markets were talking seriously about the pound going all the way to $1.05.

Image:
The pound hit 31-year lows versus the dollar after the Brexit result

Against the euro, the gains have been less dramatic, reflecting the single currency’s status as the best-performing major currency this year.

Sterling’s recent rally has merely brought it back to levels seen in mid-July. However, given that it was not that long ago that some people were speculating the pound might hit parity against the euro, it still represents a solid recovery.

No one is talking any more about one pound being equal in value to one euro, at least, not outside the price-gouging currency exchange units at one or two UK airports.

The reason for this rally, of course, is that the market is starting to price in an interest rate rise.

A series of events have given this sentiment impetus, including news on Tuesday this week that consumer price inflation had hit 2.9% and Wednesday’s news of another drop in the jobless rate to just 4.3%.

This was followed on Thursday by minutes from the Bank of England’s Monetary Policy Committee that revealed a majority of members believe that, in the absence of bad news, “some withdrawal of monetary stimulus is likely to be appropriate over the coming months”.


preview image

Video:
Carney: Rates raise possibility ‘increased’

That was reinforced in a speech on Friday by Gertjan Vlieghe, previously seen as one of the ‘doves’ on the MPC, in which he said “the evolution of the data is increasingly suggesting that we are approaching the moment when Bank rate may need to rise”. Mr Vlieghe added that this “may be as early as the coming months”.

These developments raise two questions.

The first is the extent to which Bank Rate may have to increase. There is a school of thought in the market that the UK economy, in spite of the robust job creation figures, is losing momentum and may continue to do so while uncertainty persists over the Brexit deal that the UK is going to strike with the EU.

That is certainly believed to be the view of Mark Carney, the Bank’s governor. If shared by most other members of the MPC, it could mean monetary policy could merely be tightened to the extent of reversing last year’s emergency rate cut made by the Bank following the Leave vote, bringing Bank rate back to 0.5%.

This view, summed up in the phrase ‘one and done’, has it that the UK economy faces several years of uncertainty and that household finances are still quite fragile. The jobless rate may be falling but earnings growth is not keeping pace with inflation. Some UK households, it is argued, might struggle to meet their mortgage repayments even if there is a modest rate rise.


 Anna Stupnytska is Fidelity International's global economist

Video:
November rate hike ‘one and done’

Yet there is also a case for going further. Inflation is well ahead of the Bank’s central target of 2%, unemployment is at its lowest level since 1975 and the UK economy is set to grow this year at around 1.7% which, while low, is not wildly out of kilter with the growth rates seen since the global financial crisis.

Add to that the fact that the UK stock market is now into the eighth year of its current bull run and, on Wall Street, the rally has been going on longer than that. We are due another big stock market reversal together with the hit to confidence that would involve.

Raising rates further now, it can be argued, will give the Bank scope to cut them again if it needs to rebuild confidence in the future.

The other question is whether the MPC can be believed when it makes hawkish noises of the kind it has been this week.

Mr Carney has, in the past, dropped heavy hints that interest rate rises are on the way – most famously at a speech at the Mansion House in 2014 and at Lincoln Cathedral in 2015 – only for him not to follow through…


Source link