The British pound rose sharply Wednesday after the country's top central banker pondered the prospect of higher interest rates, a day after his counterpart at the European Central Bank sent the euro soaring with a relatively rosy economic assessment of the 19-country eurozone.
Continue Reading Below
The big moves in the currency markets show the extent to which traders are on alert for anything that may signal that the two banks will join the Federal Reserve in bringing an end to the stimulus measures that were put in place after the financial crisis and the ensuing Great Recession.
The pound was in focus Wednesday, enjoying one of its best days since last year's vote to leave the European Union after Mark Carney, the Bank of England governor, made remarks that some interpreted as bringing an interest rate increase closer. Higher interest rates relative to other currencies can send an exchange rate higher by increasing demand for fixed-income investments in that currency.
The pound rose around a cent, or 0.9 percent higher, to trade at $1.2934. Against the euro, it was 0.5 percent firmer at 1.1136 euros.
The currency's strength came after Carney said in remarks prepared for a conference in Sintra, Portugal that the central bank would be less tolerant of above-target inflation if the British economy improves. Central banks use rate hikes to fight inflation.
He said that "some removal of monetary stimulus is likely to become necessary" if growth reduces spare capacity in the economy, and that the bank's rate-setting committee would debate the issue "in the coming months." At its policy meeting earlier this month, rate-setters were surprisingly split with three opting for higher rates against the five, including Carney, voting for keeping the base rate at the record low of 0.25 percent.
Continue Reading BelowAdvertisement
Connor Campbell, a financial analyst at trading firm Spreadex, said the market reaction appeared overdone as investors ignored the fact that Carney had "made it clear a lot of things ... need to move in the right direction" for rates to rise. These could include such things as wage growth, business investment and what happens with Brexit. Britain has triggered the two-year timetable to leave the bloc in March 2019 but its post-Brexit relationship with the EU is unclear.
The dilemma facing rate-setters at the Bank is that the pound's slump since the Brexit vote has stoked inflationary pressures by raising import prices at a time when the British economy is slowing, partly on Brexit-related uncertainties.
The jump in the pound comes a day after European Central Bank head Mario Draghi sent the euro higher by indicating the ECB could slowly withdraw some of its monetary stimulus measures as the economy improves.
Though Draghi indicated that the eventual withdrawal of stimulus would be "gradual" and "prudent," markets think a change in strategy could come sooner than thought. On Wednesday, the euro was up a further 0.3 percent at $1.1377.
The ECB's stimulus policies have included a zero interest rate benchmark affecting short-term rates and 60 billion euros a month in bond purchases that pump newly printed money into the financial system to driven down longer term rates and raise inflation. Those purchases are slated to run at least through year end, when they will total 2.2 trillion euros. Markets are waiting for a clear indication of when and how fast the bank intends to phase them out.