The Pound rallied against all of the majors yesterday as traders were wrong-footed by the Bank of England’s Quarterly Inflation report. Governor Mark Carney asserted that the current record-low benchmark interest rate of 0.50% would remain in place until the ILO Unemployment Rate reaches 7.0%. The Pound declined in a knee-jerk reaction to the statement, but as traders got their teeth stuck into the latest monetary policy modification it became apparent that the move was far less dovish than initially estimated.
The current ILO Unemployment Rate of 7.8% means that, theoretically, 750,000 Britons will need to find work before the base rate is increased – that is more than enough people to fill Wembley Stadium eight times over, or the equivalent of the whole of Nottingham, plus one full-capacity Wembley Stadium. According to BoE projections Unemployment should not reach 7.0% before 2016 and furthermore Carney described the current recovery as the “worst on record”.
If the Unemployment target and the Unemployment projections were the only information contained in the report, the Pound would likely have tumbled considerably yesterday. However, the BoE statement also included a series of factors that convinced markets to feel more optimistic towards Sterling, namely a trio of “Knockouts” and a duo of improved GDP forecasts.
The BoE noted that if the British economy strays off-track then the Central Bank retains the ability to adjust monetary policy even if the Unemployment threshold has not been reached. Essentially, the three “Knockouts” will come into play if: inflation remains above 2.5% in 18-24 months; if the medium-term inflation forecasts suggest a deviation from the 2.0% target; or if other risks to financial stability are witnessed in the UK economy.
The BoE also upgraded its GDP forecast for 2013 to 1.5%, from 1.2%, and for 2014 to 2.7%, from 1.9%. In some ways the UK Central Bank issued itself a get-out clause from its own forward guidance programme. This could prove to be a very shrewd move if the decision has the desired effect; by promising to keep rates low for a prolonged period of time the BoE has breathed life into the UK lending market, which could lead to increased business investment and therefore enhanced employment prospects. Simultaneously, the Bank has given itself the necessary flexibility to go back on its word if unforeseen economic conditions transpire later down the line
The Pound rallied when markets fully digested the release because investors interpreted the three “Knockouts” to suggest that interest rates could easily be raised, despite the 7.0% Unemployment threshold, if inflation remains above 2.5%, as it has done for the majority of the last four years. Traders were also cheered by the relatively high nominal value of the Unemployment threshold – many economists had previously anticipated a target of 6.5% inline with the Federal Reserve.
In reaction to the statement the Pound rallied higher by over a cent, rising through significant resistance levels, against the US Dollar to settle just above 1.5500. Sterling also posted a one-cent gain against the Euro, a 0.4-cent gain against the New Zealand Dollar and a 0.4-cent gain against the Japanese Yen. Against the Australian Dollar Sterling hit a fresh near-3-year high and against the Canadian Dollar the Pound rallied by a staggering 2.7 cents as disappointing Canadian PMI and Building Permits data damaged sentiment towards the ‘Loonie’.
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