Over five tough summer weeks investors have slashed their bets on a stronger pound by 75 percent as still-miserly earnings growth calls into the question the timing of the first UK interest rate rises in over seven years.
Sterling’s retreat – around 2.3 percent, or almost 4 cents, against the dollar since early July – has come chiefly via a rebound for the U.S. currency. But UK data, albeit only slightly weaker, has also had an impact, casting at least some doubt on once-popular bets that rates would rise this year.
CFTC data shows speculative investors have cut net long positions in sterling from more than 52,000 contracts in late June to just over 12,000 in the first week of August.
The Bank of England has said little to bolster expectations rates will rise this year and even if minutes from its most recent monetary policy meeting later this month reveal the first vote for an immediate hike, money markets are only pricing in a small chance of higher rates by the end of the year.
That is not to say the G7’s fastest-growing economy will not soon need to be cooled off a bit – a Reuters poll on Tuesday showed economists slightly increased their bets on a rate rise by the end of the year. But the consensus remained for it to come in the first quarter of 2015.
Deeper-rooted doubts are emerging among market participants and, it seems, policymakers too, about the labour market, inflation and the solidity of Britain’s economic upturn.
While the BoE’s quarterly inflation report due on Wednesday, with the accompanying tweak in the bank’s view on inflation and growth, should take centre stage this week, wage numbers the same day – forecast to show an outright fall in earnings – may prove just as influential.
“Policy in general in the developed world will continue to be kept looser than it ever had in times past and I don’t think the BoE is any exception to that,” said Simon Derrick, head currency strategist at Bank of New York Mellon, adding that rates could be kept on hold until after May’s general election.
The majority, who have backed sterling’s rally since the start of last year, still foresee an earlier hike and the pound remains significantly stronger against the euro and its trade-weighted currency basket than against the dollar, down just 0.5 and 0.7 percent respectively in the same five-week period.
Only five of the 55 economists polled by Reuters last month said the bank would wait any longer than its next inflation reports in November of this year or February of next.
But the tone among strategists forecasting a rise in that time frame is cautious. Overnight interest rates traded for up to one year, and forward rate agreements – which have been closely correlated to sterling in the past year – show the market pushing the first hike back into 2015.
“I suspect that they (BoE policymakers) won’t hike this year, and the reason is their inflation forecast, which is ultimately what they’re supposed to be forecasting and targeting,” says Paul Lambert, head of currency at Insight Investment in London, which manages $485.4 billion of assets.
“I don’t think it looks at this stage like they need to raise interest rates to hit their inflation target, and that’s because wage growth is still very modest, and because inflation has tended to undershoot rather than overshoot.”
Inflation in June was 1.9 percent, below the bank’s 2 percent target.
The other big issue, which U.S. authorities also have to confront again in the next year, is how to rein in ultra-loose monetary policy which may have left many markets overextended.
A sell-off in emerging markets in January was a warning of the impact tighter U.S. policy could have on riskier investments worldwide. In Britain’s case, the main concern is the housing market, where rate hikes have shocked the system in the past.
On the other hand, if rising house prices – and not improving consumer buying power – has been one of the major sources of expansion over the past year, then the past couple of months have shown the first signs of the market wobbling.
Most economists predict economic growth rates have peaked and that inflation will stay low for the near future. Analysts from U.S. investment bank JPMorgan say investors are already paying attention to weaker trends in production and a “less frenetic” housing market.
“Tactically, the pound is vulnerable from investors looking to scale back their collective long positions in the currency in response to more uneven economic data,” they said in a note to clients this week.
“UK rate expectations declined moderately over the past month and there probably needs to be a material acceleration in reported wage growth before the curve can price faster rate hikes again.”
While many analysts shy away in public from the political context of any decision by the bank, sticking to the dogma that it is independent of external influence, Insight’s Lambert says the bank will also seek to avoid a move close to the polls.
“All independent central banks tend to try to avoid shifting policy too close to an election,” he said. “But if they felt they needed to, and the evidence suddenly changed markedly… then they would.” (Writing by Patrick Graham; Editing by Ruth Pitchford)