Pound jumps after hint of interest rate hike
London • The pound jumped on Friday to reach its highest level against the dollar in nearly five years after the Bank of England’s governor predicted an interest rate hike might come sooner than expected.
The British currency rose to $1.6965 from $1.6830 the day before after Mark Carney said an interest rate rise from its current record low of 0.5 percent, "could happen sooner than markets currently expect." The last time the pound traded above $1.70 was in August 2009.
Carney hedged the hint by telling an annual banquet of bankers that the Bank of England is not pre-committed and would make its decisions according to incoming economic data.
But the warning nevertheless surprised economists and traders, many of which had been forecasting the first rate hike to come in the spring of next year. With the economy strengthening and the unemployment rate dropping to 6.6 percent in the three months ending in April, the pressure to raise rates sooner has increased.
Economists quickly updated their forecasts, with some predicting a rate hike by early 2015, or even sooner.
"We acknowledge that this forecast change is being made against the metaphorical cacophony of stable doors being slammed shut," said Ross Walker of RBS U.K. economics. "Perhaps we ought to have seen it coming."
Walker, however, pointed out that the abrupt moves in the pound and fixed income markets show that the investors did not in fact see it coming.
Carney’s first year in office has been defined by a "forward guidance policy," which kept rates low and closely tied an interest rate rise to a drop in unemployment.
But as economy the strengthened, and unemployment fell below the level where a rate rise would have been considered, "forward guidance" passed into history. In need of a way to tell the British public that change was near at hand, Carney chose a big forum to send a strong hint that rates could rise soon.
Should a rate rise happen this year, Britain would be way ahead of the ECB, which is still cutting rates — and maybe even ahead of the U.S. Federal Reserve, said Stephen Lewis, chief economist of Monument Securities.
"The markets have, for a while, suspected the BoE might be the first of these central banks to tighten," Lewis said. "Mr. Carney’s comment has served to strengthen their conviction."