BOE Walks Tightrope as Pound Jumps Most Versus Euro Since 2010

  • Trade-weighted sterling headed for biggest gain in four months
  • Officials to publish new growth, inflation forecasts next week

The pound -- set for its first monthly gain on a trade-weighted basis since July -- may be a key focus for Bank of England policy makers as they consider when to increase U.K. interest rates.

Sterling headed for its biggest monthly gain versus the euro in almost five years. With the Federal Reserve bolstering speculation that it will move before the end of the year, BOE officials meeting in London next week to discuss new forecasts for growth and inflation will have to weigh their desire to prepare households for higher borrowing costs against the risks of encouraging further sterling strength that could potentially damage Britain’s recovery.

The pound posts biggest monthly gain since June
The pound posts biggest monthly gain since June

“The Bank of England has to tread pretty carefully,” said John Wraith, head of U.K. rates strategy at UBS Group AG in London. “If it gets too opinionated about U.K. policy tightening and heads off rapidly in the opposite direction to everyone else, they really will put a rocket under sterling which will give them real problems in terms of imported inflation.”

The pound has outperformed most peers this year as investors bet that an improving unemployment rate and a predicted 2015 growth rate of 2.5 percent will prompt the BOE’s first rate increase since 2007. That pushed a trade-weighted measure of the currency to a seven-year high in August. It rose 1.8 percent since the end of September, it’s biggest monthly advance since June.

The pound appreciated 1 percent this week to 71.24 pence per euro as of 5 p.m. London time Friday. Sterling strengthened 3.6 percent against the shared currency this month, which would be the most since November 2010. The pound climbed 0.9 percent to $1.5458, headed for its first monthly gain versus the dollar since June.

BOE Forecasts

The central bank is due to publish new forecasts for growth and inflation alongside its latest policy decision and a record of how each member voted on Nov. 5. While the pound has risen, it’s still about 2 percent lower than the starting point for August’s forecasts, meaning the growth and inflation forecasts could be increased.

Sterling reached its strongest level in two months against the euro on Friday, after Fed officials on Oct. 28 revived speculation they will move in December, which many investors view as a precursor to a liftoff by the BOE. That heightens the potential for further divergence in policy between the U.K. and the euro area, where European Central Bank President Mario Draghi has said policy makers will reexamine the scope of their quantitative-easing plan in December.

While the possibility of more ECB asset purchases has added to upward pressure on sterling against the euro, more stimulus in the U.K.’s biggest trading partner could prove a boon for the British economy, according to Mike Amey, a London-based money manager at Pacific Investment Management Co.

“It’s a bit more nuanced than saying it pushes back rate hikes,” Amey said. “On the one hand, sterling would tighten monetary policy and push out rate hikes. On the other side, if the stimulative effect on the euro-area economy is sufficient the U.K. economy would be better able to tighten post-Draghi.”

Inflation Target

Even so, if BOE policy makers want to see inflation moving back toward their 2 percent target, they’ll likely want to keep a lid on too much pound appreciation.

“Sterling is a bigger hurdle to the BOE than they would like to admit,” said Philip Rush, an economist at Nomura International Plc in London. “With the Fed appearing to be moving closer to their exit, the risk of them delaying -- and meaning the BOE also has to delay -- is diminishing.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE