GBP Pops On BoE Dissent, USD Remains Heavy

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

Thursday's best-performing currency was sterling, which shot higher on the back of the Bank of England’s monetary policy announcement. Although recent data has been weak and policymakers noted that there were few signs of growth slowdown and softening wages, the talk in the central bank is not about easing but tightening. According to the minutes, a number of policymakers believe that a “rate hike could be needed sooner” with MPC policymaker Kristen Forbes voting for an immediate 25bp hike. This dissent caught the market by complete surprise and sent sterling sharply higher. Forbes believes there is less justification to tolerate above target inflation and for this reason sees the need for tightening. While we don’t expect the Bank of England to raise interest rates any time soon, the level of dovishness within the policymaking ranks is diminishing and if not for the risk of Article 50 being triggered next week, GBP/USD would probably be trading much higher as investors cover their short positions. The unexpected hawkishness of the central bank is another reason why we believe that when Article 50 is triggered, GBP will fall but the sell-off should be short-lived. Thursday's move has taken GBP/USD to 1.2375, right below the 50- and 100-day simple moving averages. The rally could stall here this week but if GBP/USD breaks above 1.2400 on Friday, we could see an extension to 1.25.

The U.S. dollar rebounded against the commodity currencies and stabilized versus the euro but remained under pressure against the Japanese yen, Swiss franc and sterling. USD/JPY is testing 113 and is having difficulty breaking below it with U.S. rates rising. U.S. data was also healthy -- housing starts rose 3% against a 1.4% forecast, building permits fell more than anticipated but jobless claims declined and the Philadelphia Fed manufacturing index beat expectations. Expectations for a June hike also increased slightly to 53.5%. Clearly investors don’t want to give up on the long dollar trade but it will be some time before there’s enough data to convince the Fed to move in June instead of September. Friday’s industrial production and University of Michigan consumer sentiment reports won’t provide much help even though activity and confidence is expected to improve. We think USD/JPY has found a new trading range between 114.50 and 112, with the downside likely to be tested before the upside. The Bank of Japan also left interest rates unchanged with the central bank expressing continued concern about low inflation. They said CPI excluding food and energy is stagnating and while prices are keeping momentum toward 2%, the move lacks strength. In his press conference, Governor Kuroda said,”There is still distance to the 2 percent inflation target, and to achieve it as soon as possible, it is appropriate to continue the powerful easing under the current framework.” In other words, BoJ policy will remain extremely accommodative for the foreseeable future.

The big story in Asia was China’s interest-rate hike. The People’s Bank of China raised interest rates in lockstep with the Federal Reserve. According to the central bank, “With the economy steady, inflation rising and real lending costs going down, financial institutions have strong incentives to expand credit, and housing prices have surged in some cities.” This prompted a tightening that was very much in line with market expectations. The reaction in AUD and NZD was limited although both currencies traded lower Thursday on the heels of softer data. On Wednesday night, New Zealand reported GDP growth of 0.4%, well short of the 0.7% increase expected. Australia also reported less-than-stellar employment statistics with employment change showing a decline of -6.4k, a far cry from the 16.0k increase that was anticipated. The unemployment rate also rose from 5.7% to 5.9%, the highest level in more than year. Although full-time jobs increased, the losses in part-time work and the disappointments elsewhere made the report AUD negative. There were no major economic reports from Canada but with oil prices rebounding and U.S. yields ticking up, USD/CAD appears to have support above the 20- and 50-day SMA at 1.33.

In a relatively quiet trading session, EUR/USD was confined to a tight 40 pip. Terrorist attacks in France capped gains in a currency that was supported by the far right’s failure to win the election in the Netherlands. Data was also not supportive as core consumer price growth in the Eurozone eased. ECB’s Liikanen came across the wires today with somewhat of a mixed message, indicating that growth in the Eurozone was becoming more broad based but inflation targets are yet to be met and stimulus is still necessary. ECB’s Nowotny also chimed in saying that current global political situation can lead to greater downside risk. Trade-balance figures for the Eurozone are due for release Friday. The Swiss franc traded sharply higher after the Swiss National Bank’s monetary policy announcement. Although interest rates were left unchanged, SNB President Jordan said they need to remain vigilant in the current uncertain environment, adding that while they are not a currency manipulator, they have leeway to intervene and cut rates further.