Indeed, the currency market shrugged off Thursday’s weaker-than-expected data, which indicated Britain had entered a technical double-dip recession.
EURGBP remains close to 20-month highs, supporting the view that, in the absence of a free-floating EURCHF, the relative safety of sterling over the euro has led to short-EURGBP to become the new short-EUR proxy trade.
GBPUSD is also at multi-month highs, sitting comfortably above $1.62, while on a trade-weighted basis, the pound is at its strongest level for more than two years.
| Trade-weighted sterling |
| Source: Citi |
Sterling’s strength might come as a surprise following the first official estimate of UK GDP in the first quarter of 2012 at -0.2%.
Markets will, however, be aware that the first estimate – which is based on around only 40% of the required data – is subject to future revision. Other recent economic data – notably the stickiness in inflation and robust PMI figures – paint a different picture of the UK economy which the BoE’s Monetary Policy Committee (MPC) must consider.
Economists say using only purchasing managers’ index (PMI) data growth forecasts would suggest positive growth in the region of 0.6% in the first quarter.
“An incremental move within the Committee, away from a loosening bias, has been in evidence for several months but this has become more distinct during April,” says Ross Walker, UK economist at RBS.
The shift has been marked in part by the MPC’s leading dove, Adam Posen, abandoning his vote for further asset purchases in April, having voted for more QE in 16 of the last 19 months, and a hawkish speech by MPC member Paul Tucker.
RBS calls for end of QE; rate hike next year
RBS’s UK economics team on Friday revised its previous forecast of a further £50 billion in asset purchases in the second half of 2012. The bank now expects no further QE measures to be undertaken this year, and expects a withdrawal of stimulus as early as the first quarter of 2013.
RBS also notes that the MPC’s inflation forecasts have been raised progressively since QE was re-started in October 2011 and recent MPC rhetoric has tended to focus more on the persistent tendency for inflation to overshoot their forecasts.
With this in mind, RBS expects the BoE to begin hiking rates in the second quarter of 2013, having previously forecast rates to remain on hold until at least 2014.
“The Bank of England minutes are early signals of a change in stance away from looking through high inflation to support growth, and towards putting more weight on now addressing inflation,” says Sara Yates, FX strategist and UK economy expert at Barclays.
Previously, the Bank was able to argue that lower wage growth was evidence of minimal second round inflationary effects and that inflation will fall in the medium term. Because of that, it was able to use QE to boost demand.
In the most recent set of minutes, the MPC expressed greater concern about unit labour costs, and second-round effects of inflation, indicating it is now more willing to look through short-term weak data to control the inflation overshooting the 2% inflation target.
It is not often that a country’s currency rallies after official data suggests the country is in a technical recession. But the relative safety of the UK currency, given the prolonged vulnerability in the eurozone, and the early evolution of the central bank’s policy towards greater emphasis on inflation targeting, makes this a special case.