Domestic Traction

Carney's Newfound Credibility Gives Credence to the Pound

There's plenty of risk in assuming a smooth Brexit.
Christophe Morin/Bloomberg

It's all going the Bank of England's way.

U.K. inflation turned out to be stronger than expected in January so it looks like central bank officials are justified in saying elevated consumer prices will prove a bit sticky. There's still some residual price pressures making their way through the economy from the weakness of sterling after the Brexit referendum, and the recent strength of oil complicates the outlook.

Just as We Thought

The BOE's newfound hawkishness confirms investor bets for at least three rate hikes in the next 18 months

Source: Bloomberg

Interest-rate futures prices have an inverse relationship to implied rates. 100 = zero rates. 99.00 = 1% Latest price of 98.59 implies 3-month sterling Libor will be at 1.41% in March 2020.

What's worrying in Tuesday's report is that core inflation, which excludes energy and food, has bounced back -- it seems domestically generated price pressures are getting entrenched in the economy. So there's plenty of data to support the recent hawkish tone from bank officials, including recovering dove Gertjan Vlieghe, who still see CPI exceeding their 2 percent target at the end of their forecast period. 

If you take Brexit out of the equation, as Governor Mark Carney and his colleagues are determined to do, then it makes sense to pay heed to the strength of the global economy. They're also more confident that there's genuine traction in domestic spending, with the consumer credit picture turning out to be far less worrying than they might have assumed a year ago. 

Real Incomes Again

The Bank's latest estimates predict that rising wage growth will exceed slowing inflation

Source: Bank of England February 2018 Inflation Report, Bloomberg

Dashed lines indicate Inflation Report predictions

From that perspective, a hike in May looks more likely, and makes sense. Short sterling futures reflect this, and traders have every reason to be more confident in their expectations for a faster pace of bank rate increases.

It's a heroic assumption to say that Brexit doesn't matter. Carney's approach has its merits -- not least that it places a heap of pressure on the government to deliver a smooth divorce from the EU. 

There's just no evidence that Brexit is going to be easy. 

Caught Between Carney and May

Economic strength and BOE policy supports sterling, but Brexit waffling keeps a lid on further gains

Intraday times are displayed in ET.

However, it makes sense for markets to believe the central bank, for now. This means sterling should stay in a tight range until the political decision-making catches up with the BOE position. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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