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Sterling: Its Carney vs Yellen – Rabobank

FXStreet (Delhi) – Jane Foley, Research Analyst at Rabobank, suggests that the conditions favouring the first UK rate hike of the cycle have ripened a little this week.

Key Quotes

“Firstly the UK data have been encouraging. While yesterday’s release of the October services PMI survey beat market forecasts it was the better tone in the manufacturing survey earlier in the week which had a more significant impact. During Q3 the UK manufacturing sector was clearly brow beaten, not least from the strength of the pound. The surprising rebound of the October manufacturing PMI suggests that sector may have shrugged off its soft patch helped by the decline in the value of the UK’s effective exchange rate from its August high. That said, the effective exchange rate has been recovering some ground in the past couple of weeks and ironically the better tone in this week’s UK data releases has helped to give more support to sterling.”

“The outlook for the effective exchange rate is likely to play a crucial part in the extent to which the BoE is likely to tighten policy over the coming years. In view of the very weak inflation pressures at present there is no obvious reason why the central bank would endorse significant currency strength by signalling an extremely hawkish bias. The pound is the third best performing major currency on a 12 mth view after the USD and the CHF and, as was reflected in Q3 data, this had created significant headwinds for UK manufacturing and exporters.”

“By contrast to the ECB, Fed Chair Yellen was bullish on the US economic outlook during her speech yesterday. She saw “the US economy performing well”. On the back of that she warned that December was a ‘live’ possibility for a rate hike. The message from the Fed’s Dudley was similar and Vice-Chair Fischer was confident that US inflation was not too far below the Fed’s goal.”

“A hawkish Fed will likely limit upside potential for GBP/USD and take some of the steam out of the UK’s effective exchange rate. That said, movements in the EUR/GBP are of greater consequence that GBP/USD for the UK effective exchange rates. There is the possibility that the Fed will lace a potential December rate hike with dovish commentary. This could reduce downside potential for cable going forward.”

“This week’s better UK data has had the effect of drawing in market expectations for the first BoE rate hike a couple of notches to Nov/Dec. Economist surveys point to Q2 for the first move, though we are predicting steady rates until August. Clearly the tone presented by Carney at today’s Inflation Report press conference will be key. Having made strong gains this week there is the potential that sterling may be a little disappointed. However, we would favour selling EUR/GBP on any rallies. That said, we expect choppy range trading in GBP/USD in the coming weeks and an absence of clear direction.”

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