Sterling Loses Its Luster in 2014

After a Surprise Rebound for the U.K. and Sterling in 2013, the U.K. couldn’t maintain its upward momentum as expected in 2014. What the heck happened?

Positive Start to the Year

It wasn’t an immediate turn in sentiment as 2014 started out pretty positive for pound bulls with the unemployment rate nearing the Bank of England’s 7% target in January and retail sales showing and annualized gain of 5.3% through the end of 2014 (fastest increase in nine years). Also, the Bank of England remained positive through February, projecting a 3.4% growth rate for 2014 and for inflation to remain under control, maybe even fall to 1.86% by the fourth quarter.

With all of this positivity going on, the market expectation was that the BOE would raise rates gradually if the economy continues to recover, but that the level of interest rates necessary to sustain low unemployment and price stability will be materially lower than before the 2008 financial crisis.

BOE Changes Its Tune

Unfortunately for Sterling bulls, the BOE started to change their tune on growth in March, citing the recent strength in the British pound as one of the reasons why inflation is expected to stay below the 2.5% threshold of their preferred ranges. They also expressed concerns that broader growth from household to business spending still had “some ways to go” before it’s balanced and sustainable.

In no time, BOE Governor Mark Carney started to change his tune on rate hike expectations: if the 7% unemployment rate threshold was breached, it would not be an automatic rate hike trigger, only that they would start to consider it. And by May, Carney decided to shed his hawkish feathers for a more cautionary stance, mainly on data showing slack in the labor market. This disappointed market analysts and moves the rate hike speculation to some time in 2015 or possibly even 2016.

It was about that time when Sterling’s run higher had seemingly run out of steam and the strong bullish sentiment started to ebb. Throughout the summer months, economic data began to point to a slowdown in the recovery (manufacturing slows, average wage growth goes negative, continued drop in inflation, etc.) and it looks like the supply of buy orders for British pounds seemed to dry up by August.

And through the rest of 2014, it was the same story of a weak job sector, low inflation and the weakening global economy that kept the Bank of England cautious that held the British pound from reaching the lofty expectations setup by a positive finish to 2013.

British Pound Price Action

GBP/USD Daily Forex Chart

GBP/USD Daily Forex Chart

Overall, price action in the British pound was steady all year long with exception to the Scottish independence vote drama in September that caused big short-term moves in Sterling. For the most part, Sterling was really just along for the ride, reacting to the big stories of the year.  Whether it was the big dollar rally on the Fed ending QE, the big Japanese yen selloff on more BOJ easing, or the weakening global economic story, the U.K. was probably the least influential contributor to currency price action for 2014.

And with the U.K.’s issues of falling inflation, the question remains on how far back will we see rate expectations be pushed back for the U.K., even with recent improvements to wage growth? Do you think it will be in 2015, 2016, or beyond?