Currency markets appear to have been caught a little short of sterling after the Bank of England struck an unexpectedly hawkish tone on the potential for a possible move in interest rates.
The pound has hit a one year high against the US dollar and jumped sharply against the euro, with the potential that we could see us head towards 1.3500 in the coming days.
This is welcome news at a time when inflationary pressures could become entrenched. It was important that the Bank of England sent a signal that they weren’t looking in a different direction to central banks like the European Central Bank, Federal Reserve and the Bank of Canada when it comes to the potential for tightening.
Today’s signalling will go a long way to help underpin the pound in the medium term, particularly if we get further hawkish rhetoric from its central bank peers, and thus help ameliorate rising concerns about higher inflation. Furthermore the reversal of some of last year’s stimulus appears much closer than it has ever been if today’s policy statement from the Bank of England MPC is in any way reflective of what MPC members are really thinking.
The trouble is we’ve been here before on a number of previous occasions, particularly in June 2014 when Mark Carney and the MPC also said suggested that “rates could rise faster than markets currently expect”
Having said that the unemployment rate was much higher at the time at 6.8% while inflation was lower than it is now at 1.5%, which means the pressure to raise rates was much less given that CPI was below the banks inflation target.
The banks concern about wage growth wasn’t as big a concern then as it is now but even so the weakness in wages may be down to other external factors that aren’t currently being priced in.
There could be something else at work here given that costs to businesses have gone up in the last two to three years, from items like the apprenticeship levy, the work place pension, as well as the implementation of the living wage which have pushed up employee costs at the bottom end of the pay scale.
This is likely to have created a smoothing out effect further up and into the middle income bracket creating a flattening or smoothing effect. If that’s the case any employer is likely to squeeze down on wages as it’s his only flexible cost, which means wage growth may pick up in the coming months but it will be at a much lower rate than previously.
It is becoming clear given today’s assessment from the Bank of England that their tolerance for higher inflation is becoming limited and much harder to justify especially with unemployment at a 42 year low.
Maybe this time it will be different, but I’ll believe it when I see it, even if markets are now assigning a 54% probability that we’ll see a rate hike by the end of this year.