Pound Bulls Face Day of Reckoning as BOE Inflation Report Looms

This week’s economic forecasts from the Bank of England are shaping up to be decisive for the remaining sterling bulls.

The pound strengthened against the euro today as investors prepared for clues from projections due in the central bank’s Inflation Report as to when it will begin raising interest rates. While sterling is the best-performing major currency in the past year based on Bloomberg Correlation-Weighted Indexes, large speculators including hedge funds last week cut bullish bets to the least since February. U.K. government bonds fell.

“In terms of key events this week, it would be the Inflation Report,” said Michael Sneyd, a foreign-exchange strategist at BNP Paribas SA in London. “Long sterling is one of the largest positions in G-10 FX, but this long-sterling positioning has been pared back the last couple of weeks,” he said, referring to bets on currency gains among Group-of-10-nation foreign-exchange rates.

The pound climbed 0.3 percent to 79.74 pence per euro as of 4:19 p.m. London time, after dropping more than 1 percent in the two weeks through Aug. 8. Sterling added 0.1 percent to $1.6786, after declining for the past five weeks.

While the pound strengthened 9.9 percent in the past 12 months, based on Bloomberg Correlation-Weighted Indexes that track 10 developed-nation currencies, it’s down 0.6 percent in the past month after traders pulled back bets on higher interest rates. That’s adding to the importance of the BOE’s quarterly report, which will be presented Aug. 13 by Bank of England Governor Mark Carney.

Potential Rebound

“If we do continue to get an indication from Carney that rate hikes are on schedule for November, then there’s scope for sterling to rebound this week,” said BNP Paribas’s Sneyd.

Carney’s justification for so far keeping the Bank of England’s benchmark interest rate at a record low has the backing of most economists, according to a Bloomberg survey.

Of 33 respondents, 22 said there’s still enough slack in the economy to justify holding the key rate at 0.5 percent, where it’s been since March 2009. The BOE has put spare capacity at about 1 percent to 1.5 percent of gross domestic product. The Inflation Report will include updates to growth and consumer price forecasts, which are used by the BOE to help determine interest rate policy.

“The degree of labor-market slack evident from wage data suggests that there is no immediate rush to move rates higher,” said Peter Dixon, an economist at Commerzbank AG in London. “Given the uncertainties surrounding estimates of potential GDP growth, there are very wide confidence intervals around” spare capacity estimates.

Rates Outlook

The BOE may revise its outlook for wage growth when Carney publishes its new projections at a press conference. While the central bank previously forecast that pay growth would approach 2.5 percent by the end of 2014, subsequent data showed it slowed to 0.7 percent in the three months through May, the lowest in at least 13 years.

That’s helped traders push back bets on the first increase in borrowing costs. Forward contracts based on the sterling overnight interbank average, or Sonia, show investors are speculating that U.K. borrowing costs won’t increase by a full 25 basis points until March.

Bets on an advance in the pound against the dollar exceeded those wagering on a decline by 12,121 contracts in the week through Aug. 5, the least since Feb. 11, the latest Commodity Futures Trading Commission data show. They climbed as high as 56,412 in July, the most since 2007.

The 10-year gilt yield rose four basis points, or 0.04 percentage point, to 2.50 percent. The rate touched 2.40 percent on Aug. 8, the lowest since August 2013. The 2.25 percent bond due in September 2023 fell 0.31, or 3.10 pounds per 1,000-pound face amount, to 97.99

Gilts returned 6.3 percent this year through Aug. 8, Bloomberg World Bond Indexes show. That matched German securities’ gain and compared with an increase of 3.8 percent for Treasuries.

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