Bank of England hints at rate rises sooner while Yellen goes dovish

• Unemployment improvement points to Q2 2015 rate rise in UK

• Eurozone GDP day kicked off by French disappointment

• Yellen confirmation speech on the side of the doves

The Bank of England yesterday conceded that rates in the UK are likely to rise sooner than had been predicted only 3 months ago. Governor Mark Carney and the rest of the MPC have decided that the “recovery has finally taken hold” in the UK and that unemployment here will probably reach its 7.0% threshold for rate rises a full 9 months earlier than it had predicted at its August meeting. Wednesday’s unemployment number would have helped things.

Alongside other metrics of the UK recovery, unemployment is continuing its recent run of improvement and will embolden those who believe that the economy here has turned a corner. As it stands at the moment, the UK is the strongest economy, and has the most momentum in the G10. Yesterday’s fall in unemployment from 7.6% from 7.7% in August suggests a trend of improvement that, if continued, would see this 7.0% threshold hit by Q4 of 2014; the Bank continues to sit on the safe side of things ascribing only a 40% probability to this and a 60% probability to the threshold being hit by end of 2015.

While the jobs market seems to be improving, we are still reticent to revise our beliefs on when the Bank of England will raise interest rates as part of its forward guidance plan away from 2015, and the cynic inside us believes that it is unlikely that we will see rate rises before the general election in May 2015. The Bank also stated that reaching the unemployment threshold would not necessarily trigger an immediate policy response i.e. we could hit 7.0% and still see rates persist at 0.5%.

Caveats exist to thoughts of near-term rate rises, of course; inflation has been revised to “just below” the 2% target from Q1 2015 and given the Bank’s original price control mandate, this may delay a tightening of monetary policy – that being said, real rates are going to remain negative for a long time and stimulus therefore will remain in place for years to come. The key, moving forward, for the Bank of England, will how it juggles its mandate of price stability and jobs growth through 2014. We believe that the Bank will always err on the side of higher inflation as a trade-off to improvements in the jobs market – you just have to look at their previous performance vs. their inflation target.

Sterling drove higher on both announcements and finished above the 1.60 level against the USD while breaking above 1.19 against the EUR. Yields on UK 10yr debt rose a per cent as investors priced in further signs of a recovery while short sterling contracts remain steadily pointing to rate hike by December 2014.

Yesterday’s Eurozone data was a mere placeholder for today’s GDP reports. As we stated on Friday, something scared the horses in Frankfurt to see a rate cut so soon after a poor inflation number and before a run of new data projections. Today’s GDP announcements were our focus and so far, so disappointing. French GDP has shrunk by 0.1% in Q3 this year it has been reported this morning – halfway back to recession before revisions. This leaves the average rate of growth for Europe’s 2nd largest economy over the past 3 quarters at 0.1% – hardly symbolic of a recovery.

German GDP has been released as expected at 0.3% for the same quarter, down from the 0.7% it hit in Q2.
Domestic demand failed to make up for large falls in exports both to the Eurozone and elsewhere. That being said we are expecting the Germans to remain the strongest economy in Europe.

The reading for the entire Eurozone is due at 10.00 GMT and will struggle to match the 0.1% growth expectation following France’s disappointment.

Euro already came in for some losses yesterday following a statement from the ECB’s Chief Economist that the bank could be ready to “purchase assets if needed to lift inflation”. Typical QE, as we have seen in the US, Japan and UK, is not available in the Eurozone due to rules that governed the setting up of the European Central Bank – governments would need to amend the rules of the Eurozone to allow asset purchases – something that Germany and Finland at the very least would likely oppose.

Asian markets have moved higher overnight following publication of Janet Yellen’s confirmation speech, due to be delivered later today, that saw the future Fed Governor remain dovish. Yellen emphasised that the US had “come a long way since the dark days of the financial crisis, but we have farther to go. Likewise, I believe the Federal Reserve has made significant progress toward its goals but has more work to do.” The market has taken that as a sign that stimulus will remain in the US – we’ll find out more this afternoon as Yellen testifies to Congress.

UK retail sales are due at 09.30 before US jobless claims and trade balance figures at 13.30.

Have a great day.

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