At the beginning of this year, most economists thought that the U.S. would lead the global economy out of recession. Now it looks like the U.K. is stealing that role. Just this week, the U.K. unemployment rate slid to the lowest level since 2008, the GDP growth is at 3%, and core inflation is back to 2%. It seems that the U.K. economy is outperforming the U.S.
The exchange rate reflects that too, and the pound’s advance seems unstoppable. Having bottomed out in July of last year, it has been on a clear upswing, climbing to nearly a six-year high against the U.S. dollar. Even when the euro is ranging sideways, the pound has kept getting stronger, marking a 22-month high versus the European single currency.
Another key reason supporting the strong Great Britain Pound (GBP) is the Bank of England (BOE) rate hike expectations. Ever since BOE Governor Mark Carney warned in early June that a 2014 rate increase was more likely than the market was anticipating, the pound has jumped higher. While he tried to clarify that the BOE does not target asset price inflation or house prices, he did contend that vulnerabilities from an overextended housing market represent risk to the domestic economy.
While the key benchmark rate has been kept at 0.5% since March 2009, the market has now fully discounted a 25-basis-point rate hike by February of 2015, and more people are looking for a possible rate hike as early as the fourth quarter of this year. This is in sharp contrast to the eurozone where market participants are wondering when the European Central Bank may have to even contemplate possible quantitative easing! It also is in contrast to this week’s testimony by Fed Chairman Yellen assuring the market that the Fed will not rush to raise rates until the labor market improves.
My view: This GBP rise was not expected. I believe the market is still establishing fresh GBP long positions so it seems too early to call it the top for the GBP. That being said, wage increases and productivity are still low there, indicating the labor market has much slack. Unless these uncertainties are addressed, I believe the BOE will remain cautious on rate increases.
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