The stronger the UK macro data, the closer the point at which the Bank of England will raise the base rate. If this is the case for the upcoming six months, further upward pressure to sterling's appreciation can be expected.
At the Inflation Report hearing before the Treasury Select Committee (TSC) last week, its member Pat McFadden described the Bank of England (BoE) as an "unreliable boyfriend - one day hot, one day cold, and the people on the other side of the message are left not really knowing where they stand."
McFadden's bold words reflected a mix of dovish and hawkish comments and speeches from the BoE's top officials, among them BoE Governor Mark Carney, who in his unexpectedly hawkish speech at Mansion House on June 12 switched from his traditional dovish tone to a rather hawkish perception of monetary stance.
"There's already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced. It could happen sooner than markets currently expect," Carney said in his Mansion House speech.
Carney's comments were then reflected in the June Monetary Policy Committee (MPC) minutes, which said it was surprising that markets were not pricing in the first rate hike before the end of this year, given the expectations that the growth in the second half of 2014 maintains its current pace.
"Analysis of options prices suggested that market participants put only around a 15% chance on a rise in Bank Rate by the end of 2014," the June minutes said.
Sterling to move in line with macro data
Carney's hawkish speech on June 12 quickly sent sterling soaring to near five-year highs, with markets realizing there is a real option on the table that the rates may start increasing before the end of this year, given the macro data between July and December this year remain on the upside. In other words, the stronger the data, the bigger the chance the central bank will hike the rate at the end of 2014, with an upward pressure on sterling increasing consequently.
However, soon after his Mansion House speech, Carney descended back to his longer-term dovish sentiment during the Inflation Report hearing at TSC, when he said there was more spare capacity to be absorbed before the rate hike. His comments immediately reversed sterling's curve below the psychological level of $1.7000.
Also, speaking before the TSC on June 24, Carney said his Mansion House comments on earlier rate hike expectations were to correct the markets, as shown in the June MPC minutes.
Commenting on sterling's possible path in the upcoming months, Josh Ferry Woodard from the FCF wrote in a research note last week that "It looks like the pound to US dollar exchange rate could fluctuate around the $1.7000 level for some time to come as investors fret over the timing of interest rate rises from the Bank of England and the Federal Reserve."
"The BoE is likely to start raising rates considerably sooner than the Fed, which means that British data is liable to have a more protracted impact on GBP/USD over the next few weeks. Any positive indicators could boost the pound, whilst any negative results could send the US dollar higher," he added.
Weak inflation, wages to give BoE more leeway with rate hike
Carney's dovish comments at the TSC were later reflected by other MPC members, Andrew Haldane and David Miles, who both said there was little evidence the central bank should be under increased pressure to raise rates sooner rather than later, citing weak wage growth and subdued inflation as the two primary reasons.
"It's not that there aren't pockets of pressures, wages are still quite squeezed for example, we are not in a situation where wage pressures or inflation pressures are tearing away, and that's a good thing as it would put pressure on us to be raising interest rates quickly and the fact that interest rate pressures are quite subdued means we are not under that pressure, which is quite a happy place to be in," Haldane said.
In his subsequent comments, Haldane also said the reaction of borrowers to rate increases may be sharper now than in the past, adding that even when rates begin to rise, they should not reach more than 3% in the medium term.
Policy path to be data driven
In terms of the near-future path of the base interest rate, the most important comment made so far by the central bank's top officials is Carney's note that "the exact timing of that [increases in interest rates] will be driven by the data, but the most important aspect of the guidance that we are giving is that our view is that the increases in rates over the forecast horizon, in our best estimation, will be limited and gradual."
Therefore, each significant macro data published between July and December this year will be very closely watched by the markets. Namely, data on wage growth, employment, inflation, business surveys, housing market, and others will be closely eyed by the policymakers.
Those data are also expected to increase pressure on sterling's volatility in the upcoming months. The better the macro data, the more upwards pressure on sterling, with the markets expecting an earlier first interest rate hike.
So far, markets expect the first rate increase of 25 basis points in the first quarter of 2015, with some economists pushing their expectations closer towards the end of 2014. There are also some who expect the first vote for the rate hike as soon as this summer if wage growth data and other macro figures support the case for tightening the policy sooner rather than later.