Sterling Shines

Strong employment and earnings data in the UK lifted sterling to the upper end of its recent range near $1.5450.  A break would quickly target the $1.5500-$1.5600 area. The claimant count fell by 38.6k, which is about 50% more than the consensus expected, and the December decline was revised to 35.8k from 29.7k. The unemployment rate fell to a new cyclical low of 5.7% (ILO measure).   

Earnings growth, reported with an extra month lag, rose 2.1% at a year-over-year pace in Q4 14. The consensus was for a 1.7% increase. The jump in earnings comes as the BOE minutes highlighted the expected upward pressure on earnings (toward 4%) and the rise of a jump in inflation when the oil increase drops out.  

There are two cautionary elements. First, the increase in aggregate hours worked warns that productivity remains weak. This speaks to the growth capacity of the UK economy. Second, the labor market may be tightening, but the earnings growth was flattered by bonuses. Excluding bonus, earnings growth actually slipped to 1.7% from 1.8%. 

That said, there is probably more room for interest rate expectations to adjust, and that means upward pressure on UK rates, especially at the short-end. Gilt yields are also backing up, and at 1.81% today, the 10-year yield at its highest level this year. This represents about a 50 bp increase since the Jan 30 low. The FTSE was trading at seven year highs before the data. The rise in yields appeared to have sapped the early upside momentum. 

Sterling is easily the best performing currency today, gaining about 0.5% against the dollar. The greenback is firmer against the other major currencies and most emerging market currencies. There is a full slate of US economic reports today, including housing starts and permits, PPI, and industrial production. However, these data points are unlikely to provide fresh trading incentives, outside of the headline effect.  

Investors seem more focused on the FOMC minutes that will be released later in the session. The new twist to the FOMC statement was the reference to international developments. Many participants read this as a caveat to the mid-year tightening story. We are less convinced. It is not that the reference to international developments was perfunctory, but given the European events it was prudent. At the same time, whatever concern there was likely eased. Note that assuming a modest downward revision to US Q4 GDP (based on newer trade and inventory data), it appears that both Germany and Japan grew faster than the US in the last three months of 2014.