The timing of the first rate hike by the Bank of England (BOE) could very well get pulled forward, wrote Barclays analysts in a research report as financial markets continue to react to a more hawkish Federal Reserve (Fed).
In terms of currency rates, the hawkish 'surprise' from the Fed has led the sterling pound to edge lower after turning around from multi-year highs earlier in the year. The latest decline, with the pound trading down to around $1.65, has been part of a broad US dollar
rally triggered by the Fed.
A major factor behind the pound rally has been higher rate expectations. Until recently, the BOE was expected to be the first central bank among the major economies to hike interest rates. However, Fed Chairman Janet Yellen's indications of a possible rate hike by early 2015 make it a tough call.
Nonetheless, according to analysts at Barclays, the BOE could become increasingly hawkish as well. As they see it, an improving growth outlook, falling labour market slack and increasing inflation should put upward pressure on rates over the course of 2014. For now, however, they believe downside surprises to inflation in the first quarter will temporarily keep at bay large interest rate moves.
Barclays continues to see the potential for the BOE to hike rates first and expects markets to price in the possibility of hawkish surprises from the British central bank. "Given the rapid fall in the unemployment rate in H2 13, labour market slack in the UK has been closing rapidly and UK consumer price index inflation is not too far below the BOE's target. Upside surprises in the data could very well cause the timing of the first hike to get pulled forward."
Meanwhile, the analysts also expect a decreasing unemployment rate and falling labour market slack to exert upward pressure on inflation in the US and hence on rates. However, given the subdued levels on core personal consumption expenditure at the moment, they are hard pressed to see the market challenging the timing of the first Fed hike in the second quarter, and believe the larger move higher in market rates will take place in the second half of the year.
Barclays believes the Fed may wait a little longer to initiate the hiking cycle, but may then hike at a faster pace than the market is pricing.
Given the move to qualitative forward guidance, Barclays expects the market focus to increasingly shift towards the inflation outlook. The primary considerations for rates in 2014 would be the evolution of the inflation outlook globally, as well as developments in the US and UK labour markets. These are the key factors expected to drive the monetary policies at the central banks.