The pound rallies

The pound rallied against the euro and US dollar in particular yesterday following the release of the latest Bank of England quarterly inflation report which was highlighted by the BoE lifting its growth forecasts for the UK economy. The BoE also signalled that an interest rate hike could be in store at some point in 2015.

Even the mere possibility of an interest rate hike next year was sufficient to drive the pound to register strong gains across the board but in particular against the euro.

The BOE now expects the UK economy to grow by 3.4% in 2014 (compared to its last forecast of 2.8%) and the unemployment rate is expected to move below its 7% threshold in the near future.

In addition and as widely anticipated, the BoE has completely revamped the framework for its much discussed 'forward guidance' policy.

The BoE is still striving to achieve a balanced and sustained economic recovery but is now focused on the need to reduce the amount of excess slack in the economy by deploying a range of indicators to better gauge the degree of spare capacity in the economy.

The criteria is now as follows:-

1. The MPC aims to absorb all the spare capacity in the economy by 2016.

2. The MPC judges that there remains scope to absorb spare capacity further before raising interest rates.

3. If and when the time comes that the economy can sustain higher interest rates, the Bank Rate is expected to rise but only in a gradual fashion.

4. Any increases in Bank Rate should be limited.

5. The MPC intends to maintain the stock of asset purchases until the first rise in Bank Rate.

The pound’s rally was particularly strong against the euro after the latter was hit by data showing that industrial output for the euro zone fell by 0.7% in December after a downwardly revised 1.6% increase in November, a much worse result than had been expected by analysts.

In addition, comments attributed to European Central Bank (ECB) main board member Benoit Coeure that the ECB are ‘seriously’ considering turning interest rates negative in the euro zone hit the single currency hard.

Overnight, the latest unemployment data out of Australia showed Australian unemployment has now reached its worst level in a decade with the unemployment rate increasing to 6% in January, up from 5.8% in December 2013 and well above analysts' predictions. The data showed that the Australian labour market lost 3,700 jobs in January, against predictions that 15,000 new ones would be added. The Australian dollar was predictably hit hard on the news release.