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Pound falls as Carney rules out early rate rise

by Daniel Grote on May 14, 2014 at 12:50

The pound dropped after the Bank of England stuck to a forecast of interest rate rises in the second quarter of 2015, dashing hopes of those who thought the recovering economy would necessitate an earlier hike in interest rates.

After two sharp falls this morning following the release of unemployment and earnings figures plus the Bank of England’s quarterly inflation report, sterling is down 0.33% at $1.6770.

Bank of England governor Mark Carney said the economy was ‘heading back to normal’ but that more work still needed to be done. ‘Securing the recovery is like making it through the qualifying rounds of the World Cup,’ he said. ‘We’re setting policy in order to win that prize.’

Stephanie Flanders, economist at JPMorgan Asset Management, said the lesson from Carney's press conference was 'that markets have got a little ahead of themselves in pricing in a rate rise this year'.

'It's worth noting that governor Mark Carney also issued a timely warning to investors regarding the current very low levels of market volatility,' she added. 'As the economy - and policy- started to move towards normality, he said investors should expect volatility to get back to normal as well.'

Orla Garvey, sovereign fund manager at Aviva Investors, said the Bank of England's stance of resisting rate rises, despite unemployment dipping to levels that would previously have triggered discussion of a hike under its now-revamped 'forward guidance' policy, could lead to inflationary pressures.

'What's really interesting is the central bank has dropped their assessment of the rate of equilibrium for unemployment to between 5.25% and 5.5%. Previously, this was much higher at around 6%. Only last August, the Bank of England's forward guidance suggested interest rates could rise soon after unemployment fell below 7%,' she said.

'Our concern is that the Bank's dovish stance will do little to stem long-term inflationary pressures and we expect forward markets to reflect this.'

Fall in jobless number disappoints

The Bank has kept growth forecasts unchanged but lowered unemployment forecasts after another fall in the jobless rate. Office for National Statistics (ONS) figures this morning put the rate at 6.8% over the three months to the end of March, down from 6.9% in the three months to the end of February, itself a sharp drop from the previous two 7.2% readings. However, earnings growth of 1.7% for the first three months of the year, the same level as is in the three months to the end of February, disappointed.

Azad Zangana, economist at fund group Schroders, said the headline figures hid a large rise in the number of self-employed workers, with 183,000 of the 283,000 jobs created during the period going to the self-employed, which suggested there was still a large amount of slack in the labour market.

'While there is no doubt that work patterns are changing to increase flexibility for both employers and employees, we are concerned that the shift away from full-time formal employment is contributing to the dismal productivity growth the economy has seen in recent years,' he said. 'Moreover, we suspect that a large proportion of the recently self-employed would return to being employees once the economy accelerates further. This is significant as it suggests that there is a greater degree of slack in the labour market, which bears down on the growth in wages.' 

Chris Williamson, chief economist at Markit, said it was alarming how much perceived slack in the economy 'which is notoriously difficult to measure' was dictating Bank of England interest rate policy, especially in the light of ONS plans to revamp how it measures the UK economy. 'With the ONS set to completely rewrite economic history in wide-ranging national accounts revisions in the autumn, the degree of uncertainty under which policymakers are operating should not be underestimated.'

The FTSE 100 meanwhile slid from its highest close in more than 14 years, with ITV leading the fallers after a disappointing trading update.

The blue chip index shed nine points, or 0.2%, to 6,858, with ITV the biggest faller, dropping 10.5p, or 5.5%, to 180.5p after the broadcaster’s expectations for advertising revenue underwhelmed traders.

ITV (ITV) said advertising revenue would rise by 12% to 13%, thanks to the effect of the football World Cup. ‘The net advertising revenue comment is more or less as we expected but some bulls may have wanted more,’ said Steve Leitchi, analyst at Investec.

Housebuilders also lost ground after strong performance yesterday. Barratt Developments (BDEV) shed 9.6p, or 2.5%, to 376.7p while Persimmon (PSN) dropped 17p, or 1.2%, to £13.87.

Compass (CPG) was among the big risers, adding 29p, or 2.8%, to £10.60, after the caterer announced it would return £1 billion to shareholders through a special dividend and raised its interim dividend to 8.8p per share.

Mondi (MNDI) was another big riser off the back of strong results. The packaging group rose 28p, or 2.7%, to £10.59 as it announced a 13% rise in profits during the first quarter of the year. ‘This morning’s update from Mondi is certainly worth the paper it is written on as investors look pleased,’ said Tom Robertson, trader at Accendo Markets.

EasyJet (EZJ) staged a modest recovery after dropping 4% on Tuesday in the wake of £60 million losses over the first half of its trading year. This morning it rose 22p, or 1.3%, to £16.80.

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