GBP direction hinges on jobs numbers
Mark Carney, the new governor of the Bank of England placed jobless numbers centre stage on Wednesday tying monetary policy to a 7% unemployment figure before it will be reviewed. With an economic recovery under way in the UK, GBP's bias over the short- to medium-term is likely to be upwards.
With the housing market and domestic consumption playing a key role in the UK's economic recovery, and if sustained, the current rate of unemployment in the UK is likely to fall quite quickly from the current 7.8%.
This new stance means forex markets will pay even closer attention to UK jobs numbers. Clusters of resistance around GBP/USD 1.5600-1.5700 may soon be challenged and even 1.6000 could be in sight by the end of the year.
Carney mentioned the prospect of keeping the Bank of England base rate at 0.5% out until 2016, but a domestically driven recovery could see that stance reviewed sooner than that. Indeed, the Bank has recently been revising UK GDP forecasts upwards. Nonetheless, as Carney noted the UK's recovery is the weakest on record and there is still over-capacity in the economy to be absorbed.
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However, Carney also laid out a number of caveats to this potentially rosy scenario for monetary policy. He rightly mentioned financial and price stability as important considerations.
The problem is that the UK's recovery is in large part being driven by the real estate market, supported by government policy, and domestic consumption. Households still hold high levels of debt and have seen their consuming power eroded by years of below inflation pay rises.
This feeds through to the current account deficit at 3.7%, higher than it was a decade ago, and at a level, which has traditionally been bearish for GBP. Right now the forex markets aren't focussing on that and probably won't unless it starts to balloon, which would be bearish for GBP. Offsetting that is stronger US growth and possible tentative signs of a Eurozone recovery, which should absorb more UK exports. But that can't be taken for granted.
The previous focus on exports and business investment, which has not been particularly successful, is being quietly shunted into the background as the ruling Conservative / Liberal Democrat coalition government focuses on the general election to be held by May 7, 2015.
For as long as the UK's economic structural deficiencies don't bleed through to the surface the outlook for GBP is bullish, but sustaining and even fuelling existing economic imbalances is dangerous and will eventually come back to haunt GBP in a big way later on if they're not addressed by policy measures or a prolonged global economic recovery. But for now enjoy the party!