FX Daily: “Sooner” UK rate hikes – less to do with faster growth and more to do with rising risks

13th June 2014

  • BoE’s Carney, speaking at the Mansion House dinner, said the first rate hike may be earlier than markets expect and the decision on rate hikes is “becoming more balanced”. (The FT)
  • UK’s Osborne says the BoE will get new powers to prevent people taking out loans that are too big compared to their income or assets. However the necessary legislation may not be passed this year. (The FT)
  • ECB’s Weidmann said sovereign bond buys can undercut central bank’s stability mandate and although QE is a widely used central bank tool, it is still a risky monetary policy. (MNI Market News)
  •  The BoJ decided Friday by a unanimous vote to leave the bank’s policy target unchanged as expected at its two-day monthly meeting, maintaining its overall economic assessment. (MNI Market News)
  • Eurozone issuance YTD of inflation-linked bonds is running at around 65% of their total 2013 level, underlining the surging market. (The FT)
  • Home sales transactions in Beijing during the first 10 days of June fell to their lowest level this year, according to data from Centraline Property, a leading property consultancy. (China Securities Journal)
  • The PBoC is expected to continue with selective injections of liquidity into the banking system to stabilise money rate expectations. (China Securities Journal)
  • The bulk of Iraq’a oil infrastructure is not at risk from the Sunni militants that have made steady gains in Iraq this week, although, that could change should they expand their reach into the eastern and southern regions of the country. (MNI Market News)
  • China’s Industrial Production rose 8.8% on the year in May, as expected up from 8.7% in April.
  • China May Retail Sales rose 12.5% on the year, up from 11.9% in April.
  • China’s May Fixed Asset Investment Excluding Rural rose 17.2% on the year, as expected. The reading was down from 17.3% in April.

Just to be clear, Carney’s call for “sooner” rate hikes was not based on a bounding UK economy. Carney still sees the degree of spare capacity in the UK economy as 1-1.5% and forecasts that growth will slow into the second half of the year. In his speech, he underlined that the UK economy has all the same imbalances as it used to as well as some new emerging ones- a highly indebted private sector. Carney had consistently said that containing housing market instability was the job of the FPC and that monetary policy was a last line of defence. However while Osbourne granted the Bank of England a raft of new rules to tame in the housing market, the legislation won’t be passed until next year- helpful! It looks like dealing with the housing market is now back in Carney’s ball court as the use of macro-prudential rules is tied up in bureaucracy. There is also a new flashing red light on Carney’s dash board of economic indicators – the emergence of significant overseas boarding. The eurozone’s ultra-low borrowing cuts are encouraging the UK private sector to borrow abroad, but the appreciation in sterling-euro cross means these debts could be multiplied, putting private sector debt levels at severe risk.

This is Carney’s first hawkish statement since coming to power and likely reflects a shift in outlook at the Monetary Policy Committee, which had shown signs of more division over spare capacity and rate rises for several meetings now. Carney’s comments yesterday are likely preceding the first official vote for higher interest rates and all eyes will be on the voting ratio at next week’s minutes. Sterling-dollar has seen some consolidation in recent days as sterling long positions took profit but the BoE emerging as the first leading central bank to hike means the only way for the pound is up. We are expecting sterling-dollar to break $1.70 during the summer. The biggest impact of a stronger pound will however be in the euro-sterling cross, where the divergence in monetary policy is most pronounced. A dovish ECB against a hawkish BoE is an easy play for currency trades and euro-sterling should stay beneath £0.80 in the near-term.

The standoff between the Bank of Japan and the Japanese Government continued overnight and the forex market remains a pawn in its game. The Bank of Japan reissued their policy statement word for word. Their only edit was a change in their view on overseas economies from “starting to recovery” to “recovering”. The statement gave no hint that an increase in quantitative easing is coming as the council maintained their view of a moderate domestic recovery, despite the April sales tax. In the post meeting press conference, Kuroda maintained their outlook for reaching a 2% inflation target between 2014-2016 and that QQE was having its intended effect. He made subtle hints that he expects the government to make firm progress in tackling the growth strategy, decoding from the politics, this is a call for the government to get going in opening up the labour market, tackling immigration, breaking down protected industries i.e. it’s time to shoot the elusive third arrow. The Japanese yen has been firming recently and not just against the euro. With Japan reaching its 2% inflation target and further BoJ easing looking more and more unlikely, the Japanese yen won’t be capable of depreciating further. The bigger question is will it be able to sustain these losses.