GBP/JPY highest since 21 June, BoE rate hike expectations intact

GBP/JPY soared as investors get on the carry trades and behind the pound following UK jobs data that met expectations and left sentiment in place for future rate rises from the Bank of England intact. The currencies that are expected to offer higher yields or track commodities due to inflation risks are performing the best. The risks of inflation have also kicked in on a week where plenty of Fed speakers are likely to advocate for action sooner than later. 

BoE rate hike expectations lift GBP

Firstly, UK data that the Unemployment Rate edged down to 4.5% in the three months to August, in line with economists' forecasts in a Reuters poll. Additionally, British employers expanded their payrolls to a record high in September. This leaves scopes for the Bank of England to raise interest rates as risks of stagflation are limited so long as the jobs market is improving. Money market pricing shows around an 8 basis point rate hike from the BoE priced in as early as the Bank's November meeting.

At the start of the week, GBP/USD printed a two-week high on hawkish weekend comments from BoE governor Andrew Bailey and fellow policymaker Michael Saunders, who both advocated for rate hikes. Saunders, in particular, said households must brace for "significantly earlier" interest rate rises.  Bailey stressed the need to prevent inflation. This leaves GBP vulnerable to the upside as investors back the carry trades, seeking yield from nations of whole economic are emerging from the COVID-19 lockdowns and being the first to hike rates since the start of the global COVID-19 pandemic. 

GBP downside risks, (Brexit)

On the other hand, there are risks relating to Brexit woes and the UK's energy crisis. As analysts at Brown Brothers Harriman explained, ''a hike before year-end is now fully priced in, as are three more hikes to follow in 2022.'' 

''Despite the heightened BOE tightening expectations, we believe the fundamental backdrop for sterling remains negative,'' the analysts argued. ''For cable, a break below $1.3510 is needed to set up a test of the September 29 cycle low near $1.3410.''

The UK's Brexit Minister Frost made a speech today with a plea to the European Union to allow for "significant change" to post-Brexit rules governing trade with Northern Ireland.

A day before the EU is expected to present its proposals to solve a standoff over part of the Brexit divorce deal, Frost again warned Brussels London could unilaterally waive some of the terms of its agreement if the bloc failed to budge.

"With some effort of will, we could still, despite all the problems, be in a position where the poison is drawn from this issue entirely and it is removed from the diplomatic top table once and for all."

The European Commission has said it will not comment immediately on Frost's speech before it outlines its proposals. However, the  EU has repeatedly said it will not renegotiate the protocol. Analysts at Brown Brothers Harriman are of the mind that this is going in circles. ''For the hundredth time, we must point out that there is simply no way for the UK to square the circle,'' the analysts said in a note today.

 ''That is, after the UK left the EU, there is no way to avoid a hard border somewhere between Ireland and Britain.  A hard border in the Irish Sea would not be acceptable to loyalists in Northern Ireland, while one between Northern Ireland and the rest of Ireland would bring back bad memories of the Troubles.''

"For the EU now to say that the protocol drawn up in extreme haste in a time of great uncertainty can never be improved upon would be a historic misjudgement," Frost said. "So I repeat, to conclude- let us both be ambitious and agree a better way forward."

Meanwhile, on Monday, Irish Foreign Minister Simon Coveney said Britain knew full well Brussels could not move on the ECJ. "At some point the EU will say enough, we cannot compromise more and I think we're very close to that point now," he said

The risks are an outright trade war that would be expected to harm both sides. The EU has said it would try to find a cooperative solution but has also threatened sanctions if the U.K. were to take unilateral action. 

''A costly trade war is probably the last thing Europe needs right now,'' analysts at Brown Brothers Harriman said. ''However, such a development would most likely hurt the smaller country the most.  To put it bluntly, the UK needs the EU more than the EU needs the UK.  And let’s not forget that the UK is still pushing the EU for so-called equivalence for British financial firms.''