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Sterling breaks out on hawkish Carney

by Ashraf Laidi

Ten-year gilt yields and sterling are both rallying as the Bank of England’s inflation report upgraded its view on both inflation and GDP growth, raising the former to 1.96% in 2 years from 1.8% in the November report and to 2.15% in 3 years from 1.95% in November. 2015 GDP growth was raised to 2.9% from 2.7%. BoE Governor Carney has managed to sound off a hawkish tone even as he explained why inflation has undershot further below the bank’s 2.0% target. The BoE also downgraded its view on spare capacity to 0.5% of GDP from 0.8% in the November.

The hawkish report and fairly upbeat testimony by Carney were in line with our expectations laid out yesterday here

One way to evaluate the latest expectations in gilt yields is via the performance relative to their US counterpart, as the UK-US 10-year spread shows the most extended consolidation since June 2013 and August 2012, both periods prevailing during a higher GBPUSD.

Sterling joins “USD” status

We expect further sterling appreciation ahead – even against the US dollar — as thecurrency stands alongside USD as the only two major currencies whose central banks are not on an easing mode. This says a lot in a world of relative valuation, when currencies are priced by not only their absolute levels returns, but also by their yield/capital outlook relative to the rest of currencies.

GBPUSD extends its break out of the seven-month down channel, aided by a disappointing US retail sales report and technical buyers, chasing the 55-day moving average for the first time since July. As $1.5580 stands as the next target for the bulls, GBP traders await Friday’s release of the latest UK construction output data, widely seen erasing the November losses. USD bulls will not want to look when January import price index are expected to show a year-on-year plunge of 9%, the biggest decline since September 2009. How’s that for muted inflation?

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