The British pound has surged in the Thursday session. In North American trade, GBP/USD is trading at 1.3393, up 1.40% on the day. On the release front, the Bank of England held the benchmark rate at 0.25%, but hinted at a rate hike before the end of the year. In the U.S., CPI and Core CPI both improved in August. CPI gained 0.4%, edging above the forecast of 0.3%. Core CPI gained 0.2%, matching the forecast. There was more good news from the labor market, as unemployment claims fell to 284 thousand, well below the forecast of 303 thousand.
As expected, Mark Carney & Co. opted to hold interest rates at 0.25%, where they have been pegged since August 2016. There have been calls for the BoE to raise rates in order to fend off high inflation levels, but most policymakers are of the opinion that current economic conditions do not warrant a rate hike. However, what surprised the markets was the minutes of the September rate decision, in which the BoE said that if current economic conditions continue, then "withdrawal of monetary stimulus is likely to be appropriate over the coming months in order to return inflation sustainably to target". The strong guidance from the BoE was unusual, and set the stage for a likely rate hike in November, when the BoE holds its next policy meeting. Investors reacted positively to the hawkish message from the bank, sending the pound sharply higher. At the same time, Monetary Policy Committee (MPC) members have remained consistent in their views on interest rate hikes – seven members voted to hold rates, with two members favoring a rate hike. This outcome was identical to the market forecast of the MPC interest rate vote.
Earlier in the year, the Federal Reserve was full of optimism that a strong US economy would warrant three rate hikes during in 2017. Fast forward to September – the economy has generally performed well, but the US continues to grapple with weak inflation levels. A strong labor market has not helped push inflation higher, as wage growth remains soft. Fed policymakers have retreated from their earlier optimistic forecasts, and have been counseling caution and patience regarding rate increases. As for a December hike, the odds have been below 50% for months. Currently, the odds are pegged at 46%, which is an improvement from last week. However, the positive August CPI data could be a sign that at long last, inflation is moving in the right direction. If the markets feel this is the case, the odds of a December hike should increase.
