Highest British pound since Brexit

The Bank of England’s surprise call for a UK interest rate hike “in the coming months” has kick-started a buying euphoria in the brow-beaten British pound. Sterling rose to its highest against the US dollar since Brexit with its best weekly return since February 2009 after rate-setter Gertjan Vlieghe reiterated the call for rates to rise. The chance of the British pound finding parity with the euro also looks diminished with EURGBP hitting an 8-week low. The Bank of England also made its mark on bond markets with UK 2 year gilt yields touching levels last seen pre-Brexit vote, up 30 basis points this week.

Cable traders in shock

The huge reaction currency markets mirrors the huge sense of surprise. We were surprised, not that the Bank of England have signalled a rate rise, but just on the timing. We said in a note on March 29 “If one were to look at UK inflation and unemployment data in a vacuum, Bank of England governor Mark Carney should be signalling the intention to raise interest rates. Of course there other factors at play and we don’t expect any such signal.” Our positive outlook for Sterling is summarised in the same note; “Without another UK rate cut or more quantitative easing on the table, the risks for Sterling look skewed to the upside.”

Bank of England come around

Rising inflation and the resilience of the UK economy since the EU referendum seems to shifted opinions at the old lady of Threadneedle Street. There is going to be a lot of head-scratching going on out there. Typically you raise interest rates to stop the economy overheating, but the UK economy is slowing. The thing to recognise is that any rate hike, were it to occur, would have the simple aim of getting interest rates back to normal levels.

Given that its 10 years this week since Northern Rock was bailed out, some might say the removal of emergency central bank stimulus is well overdue. A recession happens on average every five years. If the Bank of England were to raise rates, it would be sensibly arming itself for the next one. The change in tact by the Bank of England could be the biggest sign yet of a collective understanding amongst the big central banks that global interest rates need to go back to normal levels.

Surging pound busts the FTSE 100

What’s good for the pound is not so good for the FTSE 100. Once the FTSE 100 fell through 7300, its floor over the past two months, the floodgates were open and it promptly fell below 7200. Currency-sensitive shares of multinational miners to financials led the declines. Banks will benefit from higher lending margins in a rising interest rate environment if it is accompanied by higher loan demand, which isn’t necessarily the case since the UK economy is cooling off.

Domestically-orientated groups less sensitive to movements in the pound fared best. Ironically, JD Wetherspoon, the pub-chain headed by Brexit supporter Tim Martin bucked the trend after reporting higher than expected full-year sales. Merlin Entertainments and Intercontinental Hotels Group were amongst the worst fallers as investors reacted to an explosion on the London underground thought to be terror-related.