Bridging the sterling gap

November 5, 2015

We have reached the day of reckoning in the UK today with the release of the MPC decision, together with the minutes to this decision and also the latest quarterly Inflation Report. Naturally this brings significant volatility risk to sterling, probably mostly from the Inflation Report side. Currently the market is not pricing in a tightening from the MPC until the latter half of next year. This does not tie in with the message from surveys of bank economists who think a move will come earlier and in the first half of the year. As such there is a decent chance that we do see a closing of this gap, thus market expectations brought further in line with thinking from elsewhere. This can be achieved from the Inflation Report and a projection of above target in 2 years time (as this is calculated on market interest rates). The other way would be via the press conference and some more hawkish comments from the Bank of England Governor Carney. Should this scenario pan out, then we could well see cable testing the 1.55 level short-term, with EURGBP eying the 0.70 level.

Sticking with monetary policy, comments from Yellen were giving upward momentum to the dollar yesterday, with Yellen describing a move at the December meeting as a “live possibility”. This is not a big change, but just a re-iteration of her previous sentiments. That said, the dollar did benefit, with risk appetite also marginally favouring the dollar as news emerged that the recent plane crash in Egypt could have been terrorist related. On this basis, USDJPY looks interesting as it tests two month highs at 121.75.

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