Pound Drops as U.K. Data Damp Prospect of 2016 BOE Rate Increase

  • Construction and trade data signal faltering economy
  • Markets pricing in no BOE rate increase until after 2016

The pound weakened for a second day against the euro as data showed construction output in August fell at its fastest pace since 2012, highlighting a slowdown in the U.K. economy.

Sterling dropped versus all but one of its 16 major peers as separate data showed Britain posted a larger-than-forecast trade deficit in August, indicating that the faltering economic recovery might prevent the Bank of England from increasing interest rates any time soon. BOE Governor Mark Carney said on Thursday that countries can’t count on other economies for growth as trade slows and emerging markets struggle.

The data are “a headwind for sterling,” said Jeremy Stretch, head of foreign-exchange strategy at Canadian Imperial Bank of Commerce in London. “The weakness in construction and the net trade drag” could signal that growth momentum slowed in the third quarter in the U.K., he said.

SONIA - Forward contracts based on the sterling overnight index average
SONIA - Forward contracts based on the sterling overnight index average

The pound weakened 1.1 percent to 74.29 pence per euro as of 4:15 p.m. London time, its steepest decline versus the shared currency since Sept. 23. Sterling dropped 0.2 percent to $1.5318.

The U.K. currency fell against the euro Thursday after the central bank signaled in the minutes of its monetary policy meeting that there was scope to keep borrowing costs at a record low as slow inflation persists. The BOE’s official bank rate has been at 0.5 percent since March 2009.

Construction output fell 4.3 percent from a month earlier, compared with forecasts for a 1 percent increase in a Bloomberg survey of economists. The goods trade deficit was 11.1 billion pounds, compared with an upwardly revised 12.2 billion pounds in July, the Office for National Statistics said in London on Friday. That compared with a forecast of a narrowing to 9.9 billion pounds in a Bloomberg survey of analysts.

Stretch said “the minutes didn’t do anything” to prompt markets to re-price their assumption that the BOE is unlikely to tighten policy until later in, or even after, 2016. Forward contracts based on the sterling overnight index average, or Sonia, suggested that a full 25 basis-point increase in the BOE’s key rate won’t come until after December 2016.

Speaking during a panel discussion in Lima on Thursday, Carney said that this was a “pretty unforgiving environment” which underscored how BOE policy makers have had to weigh domestic factors against the turmoil abroad.

BOE Timing

Carney, however, also said that the timing of the U.K. central bank’s first interest-rate move since 2009 won’t be determined by the U.S. Federal Reserve and CIBC’s Stretch said those comments have put the timing of the BOE rate decision “back on the agenda.”

This has “certainly underlined that perhaps markets have pushed back rate expectations a little bit too far,” Stretch said, adding that he saw sterling stronger in the next three to six months.

It was a view shared by Lee Hardman, a London-based currency strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. in a note to clients.

“The relatively hawkish comments from Governor Carney support our view for further pound strength,” he said. It also helps “dampen the negative impact from the more dovish tone of the latest MPC minutes which were released yesterday.”

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