Dovish Carney kicks rate rise hopes into 2015

• Carney puts more focus on wages, slashes forecasts after June earnings contraction

• European economy creaking as German GDP contracts, France stagnates in Q2

• Market starts pricing out 2014 base rate increase

• US retail sales show slow start to Q3

Sterling has weakened significantly in the past 24 hours and sits at a 10 week low versus USD and a six week low versus EUR. For a reason why, we just need one word; wages.

The first fall in wages - down 0.2% in the year to June - in nominal terms since 2009 will come as a real disappointment for those investors and central bank watchers looking for an interest rate increase in the UK in Q4 of this year. Previous to this we have seen negative wages in real terms - accounting for inflation - but we are now seeing outright cuts to wage packets. It is increasingly strange the business sentiment surveys and official ONS data are so far apart on this issue.

The most recent set of PMIs lauded sectors for tightening labour markets and higher wage negotiations. While data suggests that former is definitely taking place the latter is far from complete and alongside weak productivity numbers, points to a jobs market that cannot be relied on yet to ably stand resilient to tightening monetary policy.

The shifting sands of forward guidance have moved so that wages are now the only data point that matters in town. Initially, forward guidance ran with a target, or "threshold", of an unemployment level of 7%. This was swiftly amended when the UK economy hit that exact level in March of this year, a time when rate rises would have been far too painful for the UK economy. And so guidance was shifted to a more qualitative measure, encompassing a more fuzzy directive of what the Bank would be looking for. We called it “forward suggestion” at the time; the emphasis was put on the Bank of England to suggest to the market when it thought rates could rise. This hit its zenith at Mark Carney's Mansion House speech in June that sent sterling flying higher as he spoke of rate rises "sooner than people expected". The focus is now wages.

While we believe the centre of gravity of when rates will rise has not shifted dramatically later in 2015, bets on a base rate hike in 2014 were given a real smack. This Tuesday, Libor/OIS markets were pricing in a 38.2% chance of some form of increase in rates by the Bank's December meeting. Following yesterday's Quarterly Inflation Report, that had slipped to 23.2%. A fortnight ago, it was as high as 45.4%. Investors are rapidly coming back to the notion that rates will stay on hold through Christmas.

Wages on average have come lower because of the demographics of the recent spurt of increased employment. The jobs that have been added to the economy and that have pushed the unemployment rate down to 6.4% have all been low paid, zero hour contracted work. Hence the improvement in youth employment; it's not 30 year olds taking these jobs, but 16-25 year olds.

Carney has lowered the wage growth forecast for the UK from 2.5% to 1.25% through 2014, currently running below inflation. Employment is consistently being revised higher – an obvious positive – but earnings growth now means more to slack watchers than had previously been thought.

We have consistently warned that real wages represent the silver bullet to killing off fears over the recovery. Real wage increases come from optimistic employers happy with business conditions, they allow consumers to re-balance spending figures from credit uptake and promote growth in generalised output with a central bank more comfortable to normalise monetary policy. Without this, we are only ever happier with our expectation that rates will remain at 0.5% into 2015. We have been looking for a sterling pull lower this quarter, and while we look for continued strength against the EUR from rate policy divergence, against the USD we are looking for a fall towards 1.65 through the coming month.

Falls against the euro have been tempered by the news that the German economy contracted by 0.2% in Q2 and that France’s had stagnated in the same period. This is the first time since December 2012 that the economy had slipped into contractionary territory. Imports actually outweighed exports and the impact of the Ukraine crisis will continue to be keenly felt into Q3.

Likewise, yesterday’s retail sales release from the US was a disappointment as well. Sales stagnated in July hinting at a slow turn into Q3 from what will likely be a very strong Q2.

Have a great day.