Carney hawks the case for higher rates

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Welcome to Hard Currency, the weekly podcast from the Financial Times looking at the topics making the running in the foreign exchange market. I'm Roger Blitz. And it's the pound that's holding investors' attention, alongside a Bank of England policy meeting, which as expected, held rates as they were, or as they are, but argued hawkishly about the need for markets A, to start pricing in-rate expectations, and B, to prepare for a rise, quotes, in the coming months, close quotes.

Is Governor Mark Carney-- now, is he justified in pushing investors towards the idea of a rate hike? Or does the data actually slightly undermine that case? With me to look at how sterling has performed in this and recent weeks is Jeremy Cook, Senior Economist at the payments provider World First.

Jeremy, just give us your early take about your surprise element of it. We saw it coming, didn't we?

Yeah. We saw it coming. And certainly, we thought that the Bank of England might almost chastise markets and the fact that they've been underpricing the risk, the possibility, of a rate hike through the summer months.

They primed the market with a story in the FT on Monday, didn't they?

Yes. Yes. And we've had this almost since the main inflation report-- that they've wanted a bit of two-way risk in sterling.

Yeah.

And obviously, the fall in sterling down to the almost record lows on the trade-weighted basis has increased inflationary pressures. You know, there's a lot more chatter about that in the past couple of weeks. So I really wouldn't be surprised if this is just the Bank of England saying to the markets, we need to get some two-way risk in sterling. We need to get the inflation hawks of our back. So 25 basis points could be coming soon.

So have they succeeded? I mean, within hours of-- we're doing this podcast within hours of the announcement. Sterling's gone up another percent.

[INAUDIBLE] percent, yeah.

It's about 2% this week. And it's now trading in this kind of 133 territory.

Yeah.

What would the bank make of that?

I think that stability is the crucial thing for the pound at the moment, and not wild oscillations, as we have seen, certainly against the euro, euro-sterling getting as high as 93 over the course of the past month. So they'll be looking for stability.

They'll also know that we haven't traded above 135 for the best part of well, about 13 months now. So between 135 and almost about 145, that's the air pocket. That's the Brexit air pocket.

Yeah.

So as soon as we get up there, you know, all hell could break loose. We could easily run higher.

We'll come into Brexit in a minute, I'm afraid.

[LAUGHTER]

But the data-- my question at the beginning, does the data justify where the BOE stands at the moment? We had inflation this week, jobs, and wages. Walk us through each of those.

I personally think the data doesn't justify a rate right at the moment, because we believe-- and the Bank of England's been pretty vocal on this-- that the expected high in inflation is just a little bit higher than the target, 2% plus or minus 1%-- so about 3.1%, 3.2%. And that will probably be hit in October or November of this year.

But that will be the top. And it will start to come lower from there. Certainly, the data that we have at World First suggests that the pricing of SMEs will start to-- the margins will start to recover a little bit towards the end of the year. And the impact, the base effect impact of sterling falling off post the referendum will start to feed out at the CPI figures.

So if inflation's the issue, we think that that no longer becomes an issue-- i.e., it's 2.9% at the moment. By the end of the year, will it be higher or lower? We think lower.

Oh, heck. I mean, what that means is we're going to have all this hawkish talk now and dovish talk later, isn't it?

Dovish talk later-- I mean, one question I was asked today-- if they hike, when do they cut again? You know, when does the economy get so bad post-referendum that they feel the need to actually cut rates again? So is it a case that they hike in November, cut in May?

Obviously, people are talking about it being an undo of the post-referendum cut.

Yes-- that one thing-- the emergency cut--

The emergency cut.

--which, I think the market will be comfortable, do you think, of a one-off hike?

I think they'll be comfortable with it, because if the Bank of England is that worried about the UK economy, that they are so worried that 25 basis points would send us spiralling down the drain, then they've got bigger problems than needing to communicate a 25-basis point rise.

OK. And the wages and unemployment stuff-- unemployment we kind of knew was heading that way.

Yeah.

[INTERPOSING VOICES]

It's the big productivity question.

Yeah.

You know, we're at NAIRU in employment. But decent wage rises are not coming through. Good inflation is, therefore, not coming through.

Is there enough on the government getting rid of this public sector pay cap to suggest that wages could come through [INAUDIBLE]?

Well, yeah. But at the moment, as we've heard from the government, it's only for certain members of the public sector. It's a bonus of 1%. And it's being bled through. So any near-term bump higher, we're seeing-- so private sector wages are OK at the moment. It is the public sector which is holding back the entire UK wage picture at the moment.

Yeah. But any movement by the government to move the wage cap isn't going to move the needle too much, we don't think.

Jeremy, how good or bad or indifferent is the UK economy? I'm kind of looking for a sense of whether-- and here we are coming to the Brexit discussion-- whether we still hold to the view that we did in the autumn of 2016, that actually, the economy has been resilient to the impact of Brexit. We still think that.

Certain sectors have been. The construction sector is basically in a recession at the moment. The output figures that we had earlier on this month-- minus 0.9%. You get a couple more months of that, and it is in a recession. Manufacturing may be starting to react a little bit to the devalued pound-- everything being on a Blue Cross sale, and everything is 20%. 20% off in services is kind of bumping along, but obviously, very tied to retail, very tied to consumer credit.

That's another issue that the Bank of England-- I would say, if you had to define the UK economy at the moment, I'd say it's kind of pre-recessional at the moment. It's almost stagnant.

Right.

And some of the growth that's come through is not the kind of growth that the Bank of England really wants to rely on.

So it's the poor relation of the global growth story, is it?

Yeah, very much so, yeah.

OK. So here we come into the nuts and bolts of the Brexit discussion, which is that sterling is at 133-- people are talking about it 135, quite soon, perhaps led by a further fall in the dollar-- does that feel Brexit-comfortable? In other words, does it feel like, given all the political noise in Brexit, the uncertainty, does that feel about right for sterling? Or does that feel a little bit inconsistent with what we think about Brexit's impact on the currency?

I think if we want to see sterling-dollar higher than where we are now, the foundations, both politically and economically, need to be more stable.

Right.

And that can be either a pickup of output in the UK economy, a stronger wage picture, better business and consumer confidence. Or it can be breakthroughs in the Brexit negotiations and the sufficient progress, which Michelle Barnier is looking for, so we can start talking about trade.

Yes.

One of those boxes needs to be ticked. If not, then sterling has risen without really the reasons for it.

But if we go through to the end of the year with a continuing drip drip of flat no, slightly negative Brexit news, does that keep sterling where it is? Do we just simply allow the data in the BOE to drive the currency?

Obviously, there's two sides to every side of things. And we have to have to bear in mind what's going to happen in Washington as well.

Yeah.

But at the moment, Brexit's not too much of a mover on sterling at the moment. We get Brexit news every single day. It can be a speech by David Davis or a speech by Michel Barnier or this upcoming speech by Theresa May. That's not moving sterling on a day-to-day basis. The overall Brexit picture will still act as a depressant.

Yes.

But in the short term, if a new policy maker-- say David Ramsden, for example-- comes out and says, inflation is too high, that's going to give sterling more of a boost than a Barnier [INAUDIBLE].

Yes, OK. Jeremy, where were you 25 years ago?

25 years ago, I would have been eight.

Right. Do you remember Black Wednesday then?

I don't. I was probably in [? double ?] French or something.

I hazard a guess that you studied Black Wednesday and particularly sterling-- so it's the 25th anniversary on Saturday of Black Wednesday-- that you studied the knock on effects of the decline in sterling after Black Wednesday and the impact it then had on the UK economy.

Do we make any connection between Black Wednesday in sterling and what happened to the UK economy with Brexit, what's happening to the economy, what will happen to sterling and where the economy is going?

Yeah. There's definite connections there, insomuch that it's a vast political change underscored by a weak economy, and obviously, fair odd gyration in the--

Which? Both?

Yes.

Yes. OK.

Both in the value and the value of sterling-- obviously, Black Wednesday I don't think is anything compared to Brexit on the longer term basis of what happens to the UK economy as a whole. Instead of it being an acute event, in Black Wednesday's case, this is more a chronic case of under-performance.

You can read through that and obviously, the recession that happened as a result. But in the grand scheme of things, this will be a slow decline post the referendum, with bumps of optimism, be it on a transitional deal or the signing of trade terms.

Right. And did you know it's also the 10th anniversary of Northern Rock?

I did. I did. The pictures of queues outside banks are flying around on the web at the moment.

Enough of anniversaries-- my thanks to Jeremy Cook at World First. Next week, it's the turn of the Federal Reserve to move the monetary policy dial as it sees fit. And the Bank of Japan is also holding its monthly meeting. So we'll discuss what they mean for the dollar and the yen. Until then, from Hard Currency, it's goodbye.