Sterling struggled to stay above $1.26 and gilts rallied after Bank of England governor Mark Carney cautioned that “now is not yet the time” to raise interest rates, tempering any concern from bond investors that the central bank is tempted to tighten policy.
The comments from Mr Carney in his Mansion House speech on Tuesday came after three members of the eight members on the central bank’s rate-setting committee voted last week to lift rates to tackle rising inflation.
Any shift in policy from the BoE, which cut its benchmark rate to a record low shortly after the vote for Brexit, required waiting to see “how the economy reacts to the prospect of tighter financial conditions and the reality of Brexit negotiations,” Mr Carney said.
Sterling dropped as low as $1.2604, and was 0.9 per cent weaker at $1.2618 in late trade in London. The currency also weakened against the euro, dropping 0.7 per cent to 88.15p against the single currency.
In the gilt market, the policy-sensitive two-year yield dropped 4 basis points to 0.12 per cent, helping keep the front end of the market below the BoE’s current base rate of 0.25 per cent. It has been below that level since the Brexit referendum a year ago and looks likely to remain there as the UK government begins the task of negotiating an exit from the EU.
Paul Brain, leader fixed income at Newton Asset Management, said: “With two-year yields consistently trading below base rates there has been an assumption that the economy will suffer from Brexit and that possibly base rates will be cut further.”
The case for UK growth accelerating from here looks challenging given the lack of wage growth, the uncertainty over the government and the longer term unknown over Brexit, Mr Brain said.
However, any reduction in austerity from the government and a weaker pound could well push the two-year gilt yield ‘’back up towards base rates in the near term”, he added.
Currency strategists said that Mr Carney’s speech suggested he remains a long way from casting his vote for a rate rise. “Carney remains concerned about the economic consequences of Brexit,’’ said Marc Chandler, a foreign exchange analysts at Brown Brothers Harriman. ‘”The takeaway is that the Bank of England is most likely not going to raise rates anytime soon.’’
That position meant it was hard to take a long sterling position, said Brad Bechtel at Jefferies International. “The UK economy is by no means in any position to hike rates in terms of the current trajectory of the fundamental data and the Brexit talks, of course,” said Mr Bechtel.
Sterling is still undervalued, he added but the UK economy was “in the midst of absorbing a giant shock to the system, the results of which are unclear”.
The governor was “emphatic in distancing himself” from the hawks on the Monetary Policy Committee and that his view was likely to prevail beyond the central bank’s August inflation report, according to Sam Hill, economist at RBC Capital Markets.
The low household savings ratio presents itself as an obvious risk to the downside for consumer spending, in addition to the clear constraint of wage growth falling behind inflation, Mr Hill said.