Carney Leaves Analysts Too Far in Front With Pledge: Currencies

Aug 14, 2014 3:52 am ET

(For a Currencies column daily alert: SALT FXCOL.)

Aug. 14 (Bloomberg) -- Foreign-exchange forecasters who’ve spent all year chasing the rally in the pound are now finding themselves too far in front after Bank of England Governor Mark Carney said officials won’t rush to raise interest rates.

Sterling tumbled to a four-month low against the dollar yesterday as Carney said rate increases would be “gradual and limited.” That widened the difference between the exchange rate and analysts’ year-end forecasts to the largest since July 2013, in contrast to the past 12 months, when the pound’s world- beating rally caused economists to consistently revise projections higher to catch up with the currency.

Carney’s comments contrast with his warning in June that the central bank may raise rates from a record low sooner than markets expected. Dubbed an “unreliable boyfriend” that month by U.K. opposition lawmaker Pat McFadden for shifting his stance, Carney then said in July that any rate increases will depend on data. Wages fell for the first time since 2009, even as the unemployment rate dropped to the lowest since 2008, an official report showed yesterday.

“I don’t know if we’ve misinterpreted him or taken him too literally, but the market has allowed itself to be led a merry dance on rate expectations,” Kit Juckes, a global strategist at Societe Generale SA in London, said in a phone interview yesterday. “The pound is following those expectations pretty faithfully.”

Sonia Contracts

The pound dropped 0.7 percent to $1.6688 yesterday in New York, after touching $1.6686, the least since April 15. Sterling this year rose from as low as $1.6252 in February to as high as $1.7192 on July 15. The median year-end estimate rose from $1.60 to $1.70 during that period.

The currency is now about 2.1 U.S. cents weaker that the $1.69 median estimate for year-end among analysts in a Bloomberg News survey, the most since July 2013, according to closing- price data. When the currency traded at about $1.68 at the end of May, the forecast was $1.65. The spot price exceeded the forecast for Dec. 31 by as much as 7.5 cents in February.

Speaking in London after BOE officials published their quarterly Inflation Report yesterday, Carney said policy makers are focusing on wages and that growth “faces some challenges.” Forward contracts based on the sterling overnight interbank average, or Sonia, show investors pushed back bets on a 25 basis-point increase in borrowing costs to May, from the February projection before the report.

Forward Guidance

Sterling was “clearly disappointed by Carney’s moving of the goalposts yet again,” Geoffrey Yu, a senior currency strategist at UBS AG in London, wrote in a note yesterday. “While we still expect the pound to benefit from policy differentials, in particular against the euro, momentum is clearly weaker.”

Bank of England policy makers maintained their key interest rate at a record-low 0.5 percent last week. Minutes of the Aug. 6-7 meeting, which will show whether the decision was unanimous, will be released on Aug. 20.

The pound rallied 0.8 percent on June 12, the biggest daily gain in two months, after Carney cautioned that the Bank of England’s first rate increase in more than seven years could be sooner than expected amid rapidly rising house prices. On June 24, when he softened his rhetoric at a parliamentary hearing, the currency dropped 0.2 percent.

BOE officials have switched the focus of their forward guidance, which provides an idea of the conditions needed for a rate rise, to economic slack and wage growth after their first policy hook of a 7 percent unemployment rate, was achieved faster than forecast.

Best Performer

Even after yesterday’s decline, the pound has strengthened 8.8 percent in the past 12 months, the best performer among 10 developed-nation currencies tracked by the Bloomberg Correlation-Weighted Indexes, as investors bet the BOE would be the first major central bank to increase interest rates.

“The Bank of England’s communication has been very transparent in terms of forward guidance and how that is evolving,” Michael Sneyd, a foreign-exchange strategist at BNP Paribas SA, said in a phone interview yesterday. “We’re in a situation where the U.K. is the only major central bank looking like they may raise rates in 2014, and that is focusing the attention on sterling. However, from here many investors view that you have to get the BOE call right to get the sterling call right.”

A BOE spokesman declined to comment beyond Carney’s remarks yesterday, asking not to be identified in line with the central bank’s policy.

Wage Growth

The Bank’s focus on wages yesterday came after a mixed labor-market report that showed the first drop in pay since 2009 and unemployment falling to 6.4 percent in the three months ended in June. The amount of slack in the economy is in the region of 1 percent of gross domestic product, the BOE’s inflation report said, compared with a previous estimate that put the mid-point at 1.25 percent.

Carney isn’t the only central banker perplexed by wages. Lackluster earnings growth also raises the likelihood that Federal Reserve Chair Janet Yellen, who has increasingly focused on pay to gauge the health of the world’s largest economy, will maintain the U.S central bank’s easy-money policies into a sixth year.

Average Earnings

“The committee will be placing particular importance on the prospective paths for wages and unit labor costs,” Carney said. “We will continue to monitor a broad range of data to assess overall inflationary pressures and the timing of the first increase in bank rate.”

Average weekly earnings fell 0.2 percent in the three months through June, the Office for National Statistics reported yesterday. BOE policy makers said they now see annual growth in wages in the fourth quarter at about 1.25 percent, down from 2.5 percent estimated in May.

“Carney has driven home the message that without wage inflation, the BOE is in no rush to raise rates,” Jane Foley, a senior currency strategist at Rabobank International in London, said in a phone interview yesterday. “The market was already starting to question if they had been starting to price in a rise too soon. Now they know they have.”