Bank of England Surprises and Disappoints

– The short term vision of the foreign exchange market was perfectly illustrated yesterday as the pound fell following a wholly optimistic and positive Quarterly Inflation report.

Growth up, Unemployment down, Pound Lower……go figure!

The Bank of England wholly predictably left interest rates unchanged yesterday with a 9-0 vote although there were a few murmurings about the inflation rate remaining stubbornly above the 2% target. The rate of asset purchases, put in place as insurance against Brexit volatility, also remain unchanged.

In the Quarterly Inflation Report the Bank raised its expectations for growth in the economy for the next three years, a sign that they feel the Brexit negotiations will not derail the things in the medium term. They also stated that the unemployment rate could drop as low as 4.5% which will bring further inflationary pressures as wage growth starts to pick up in a tight market.

The pound fell by 1.5% to trade around support at 1.2520 but managed to cling to part of the gains made the previous day. Traders were expecting a more hawkish view of interest rates and had positioned themselves accordingly. It was highly likely that a cautious Governor like Carney would adopt a wait and see attitude given the amount of potential headwinds facing the economy/currency.

The Government released its White Paper on its Brexit Negotiation Strategy. This was totally in line with the Prime Ministers recent speeches and it now has to be debated by a Parliament where a number of Members, particularly on the opposition side, face the issue of balancing their constituent’s leave sentiments with their own remain views.

Considering your next transfer? Log in to compare live quotes today.

U.S. Employment Report due for release.

The monthly jamboree that is the Non-Farm Payrolls report takes place later.

This always garners more column inches than is warranted by the actual market activity surrounding it.

Traders have learned over the years that there is little point trying to have positions through the release and even market users who need to buy or sell currency tend to shy away.

However there are certain areas of the economy that excite certain regions. Employment is the big thing in America, in the U.K. it is the housing market, in Europe inflation and in Japan, trade. There is one common denominator which is interest rate differentials and each of those variables is a major contributor.

Last month the jobs data surprised to the downside with the economy adding 156k jobs against expectations of around 175k. Expectations are similar this month and it remains to be seen how close actuality and hope are this time around. Over the past few months, there have been upward revisions to previous month’s data which has buoyed the dollar. It is a surprise that such backwards looking data can have such a large influence. Perhaps their measures of employment need to be recalibrated!

There used to be a view that in order for the economy to grow the average number of jobs added needed to be in the 220k per month range. This seems to have fallen to be nearer 175k now. This is likely a reaction to a lessening of manual labour needs given the export of manufacturing to lower cost regions.

There is a curious paradox facing the U.S administration, on one hand, which clearly wants to see trade on a more even playing field by abandoning the “strong dollar policy”, which is a theoretical position in any case, and the Federal Reserve which will need to raise interest rates to protect against inflation.

Interest rate differentials will drive the dollar higher and it may be that the U.S. will have to live with a strong dollar until the rest of the world catches up since policy and desire are moving in opposite directions.