Carney will yet get the pound back down

By Nicholas Hastings/Dow JonesMark Carney’s attempts to explain the Bank of England’s forward guidance on Wednesday certainly appear to have been a communication failure. Instead of driving money market rates lower and pushing the pound down, the BOE governor actually managed to bring market expectations of a rise in interest rates forward and send sterling to a six-week high. It isn’t that Carney (pictured) is not dovish about the UK economy. As he repeated again in a radio interview early yesterday, the economy is “in the very early stages of recovery from the weakest period on record.” His problem is that, given caveats about inflation and how far unemployment has to fall, he failed to convince markets that monetary policy will remain as easy for as long as he says it will. The markets appear to have more faith in the economic recovery than the central bank appears to. From that point of view it looks like stalemate, with the bank saying one thing and the markets thinking another. But it isn’t. And anyone betting on the pound staying strong could find themselves in trouble. First of all, the bank is unlikely to leave money market rates so out of sync with its own expectations, wrecking havoc not only on domestic borrowing costs but also on the competitive edge that UK exports were starting to show. Given that the recent flow of positive UK data is only likely to continue for now, Carney and other bank officials on the Monetary Policy Committee will have plenty of opportunity to finesse their guidance and the money markets will have plenty of time to rethink their initial reactions. We have seen a similar behaviour in the US, where market reaction to the initial announcement of the Federal Reserve’s plans for reducing liquidity and targeting the unemployment rate was precisely opposite to what the central bank had been looking for. Instead of falling, US Treasury yields rose and nearly undermined the whole point of providing forward guidance. And talking of the Fed, the US central bank could prove to be another weapon in helping to get the pound back down again, at least against the dollar. As the debate over the strength of the US economy continues, expectations that the Fed will start reducing market liquidity as early as next month are once again on the rise. As speculation increases over the next few weeks, the dollar will attract even more support and the pound should come under pressure once again. Carney will find that even though his guidance failed at the first hurdle, he still gets what he wants in time as money market rates fall back into line and the pound loses at least some of its recent shine.

Nicholas Hastings is a senior correspondent in London for Dow Jones Newswires and has written about foreign exchange for more than 20 years. He can be contacted on +44-20-7842-9493, by e-mail at nick.hastings@dowjones.com or on Twitter @NickHastingsDJ.