After a strong start to the week, sterling continued to push slightly higher in early trading yesterday, ahead of the Bank of England interest rate announcement and disclosure of the quarterly inflation report. In typical fashion of ‘buy the rumour, sell the fact’, sterling dropped on the release of the inflation report despite the positive tone from the release.
As expected, the BoE kept interest rates on hold and was non-committal on the direction of future interest rates. The BoE upgraded its expectations on growth in 2017 to 2% from 1.4% in November. The upgrade is a reaction to the continued positive flow of economic data following on from last year’s infamous Brexit vote. In addition, the BoE said that the upgrade was partly the result of higher spending and investment contained in Chancellor Philip Hammond’s Autumn Statement. However, the BoE sees the economy slowing in 2018 as it expects to see growth at 1.6%.
Looking at inflation, it is no surprise that the BoE sees this at elevated levels as sterling remains roughly 16.5%, down from levels seen pre-referendum. The central bank expects to see inflation peaking at 2.7% in 2018, well above the target of 2%. Once again, BoE Governor Carney said that the BoE is prepared to tolerate inflation running above its target. This is the main reason why sterling slid from its highs. In January, Carney suggested interest rates could go up or down as the BoE strikes a difficult balance between supporting growth and managing inflation. In contrast, his comments and tone suggested that the BoE is in no rush to be adjusting interest rates. On Brexit and Article 50, Carney stated: ‘The Brexit journey is really just beginning. While the direction of travel is clear, there will be twists and turns along the way.’ This does give the central bank room to manoeuvre if required.
Following parliament passing the vote on the second reading of the Brexit Bill, the government published a White Paper setting out its Brexit plans. The White Paper set the themes of the government’s goals for its negotiations with the European Union which consisted of 12 ‘principles’ including migration control and law making. As we have seen since the referendum, any major political developments from this could have an impact on sterling.
Construction PMI data was released yesterday morning which showed sector expansion but came out lower than anticipated. This came out on the back of the manufacturing PMI released on Wednesday with the pace of expansion hitting market estimates.
Looking to the day ahead, we have the key PMI data released for the service sector, which is the dominant sector in the UK. Services make up between 70-80% of the economic activity in the UK, so this is a key reading. In addition, the all-important monthly jobs report is set for release from the US which determines the direction of interest rates, and which could, in turn, have an effect on currency rates.