Traders Keep Calm and Carry On Through BOE’s Debate: Currencies

Aug 22, 2014 4:40 am ET

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

Aug. 22 (Bloomberg) -- Confused by the seemingly contradictory signals from the Bank of England on interest rates? Currency traders aren’t.

BOE Governor Mark Carney said in June that investors were underestimating the prospect of a 2014 rate increase. On Aug. 13, he said officials wouldn’t rush to lift borrowing costs. Three days later, he told the Sunday Times newspaper an improvement in U.K. wages may prompt tightening. Minutes of the central bank August meeting showed this week that its unanimity on rates was split for the first time in more than three years.

Through it all, volatility in the pound rose the least among the Group of 10 currencies in the past month, while sterling has fallen for seven straight weeks. That shows traders see little chance of a change in policy anytime soon with parts of the economy falling short of forecasts.

“Sterling needs to weaken,” James Shugg, a senior economist at Westpac Banking Corp. in London, said yesterday by phone. The lender was the most-accurate forecaster for the pound versus the euro in the second quarter, according to data compiled by Bloomberg. “Perhaps Carney provided a bit too much market commentary.”

Implied Volatility

Implied three-month volatility in sterling rose to 5.46 percent yesterday, from 5.4 percent on July 21 and a seven-year low based on end-of-day levels of 5.03 percent in June, data compiled by Bloomberg show. That’s the smallest increase among its major peers and compares with a 1.4 percentage-point jump in the past month to 6.57 percent for the yen.

Since reaching a six-year high of $1.7192 on July 15, the pound slipped 3.6 percent to $1.6580 yesterday in New York, when it touched $1.6564, the weakest level since April 4. The U.K. currency hasn’t experienced such a sustained losing streak since the seven weeks ending Sept. 5, 2008, when it tumbled more than 12 percent.

Westpac sees the pound dropping 1 percent to $1.64 by year- end, and predicts it will remain little changed at 80 pence per euro. Median estimates in Bloomberg surveys of more than 70 strategists put the currency at $1.69 and 78 pence.

Retail sales excluding autos rose 3.4 percent in the year through July, less than the 3.5 percent increase forecast by economists surveyed by Bloomberg, a report showed yesterday. The pound fell 0.7 percent after Aug. 19 data showed annual consumer-price inflation slowed in July to a 1.6 percent rate, from 1.9 percent the prior month.

Rate Bets

“With dovish comments from Carney last week, this fall in inflation will provide the BOE with even more reason to hold out” until the first quarter of 2015 before raising rates, Jake Trask, a dealer at London-based broker UKForex, wrote in an Aug. 19 note to clients.

Forward contracts based on the sterling overnight interbank average, or Sonia, show investors have pushed back to May bets on a 0.25 percentage-point increase in the U.K.’s base rate of 0.5 percent, from a forecast of February earlier this month.

Speaking in London on Aug. 13, after the BOE published its quarterly Inflation Report, Carney warned that Britain’s recovery “faces some challenges” and said officials would consider wages growth when looking at when to raise the record- low 0.5 percent benchmark rate.

‘Targeting Slack’

His comments contrasted with a warning in June that the central bank could raise borrowing costs sooner than markets expected. U.K. opposition lawmaker Pat McFadden likened Carney to an “unreliable boyfriend” that month for his changing pronouncements, and the BOE chief went on to say in July that any rate increases would depend on data.

“The Bank of England has gone from targeting unemployment, to targeting slack to targeting wages,” Joakim Tiberg, a rates strategist at UBS AG in London, told Bloomberg Television on Aug. 20. For sterling, “near-term momentum is clearly weak,” he said, though the bank forecasts a gain to $1.75 by year-end.

Saxo Bank A/S, which sees the pound falling to $1.62 by year-end, says there’s more confusion in sterling markets than some indicators might suggest.

“The market is muddled,” Nick Beecroft, a senior analyst at Saxo in London, said yesterday by phone. “There’s 50 percent of the market that believes” the BOE’s signals on rates, while the other 50 percent “doesn’t believe any of that” because policy makers “have flip-flopped on guidance,” he said.

A renewed focus by traders on the economy in coming months will push volatility higher, Asmara Jamaleh, an economist at Intesa Sanpaolo SpA in Milan, said yesterday by phone. The Italian lender predicts the pound will strengthen more than 3 percent by year-end to $1.72.

Even so, “because the likelihood of a rate hike this year is small,” the pound will remain below $1.70 in the “short term,” she said.