Welcome Back, Sterling. Come in, Sit Down, Stay a While

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(Bloomberg Gadfly) -- Sterling is back into its pre-Brexit referendum range versus the dollar, quite an amazing achievement from the depths of Brexit despair in late 2016. While dollar weakness has driven all the major currencies stronger, some of the fire under sterling has been driven by the Bank of England's recent desire to raise rates.

That desire, like many things in life, has limits. For anyone wanting to know where it will go from here, the central bank has the answer.

Investors have very much priced in a second BOE rate hike of 25 basis points to 0.75 percent on May 10. The bank fought long and hard to convince them that tighter policy was necessary, warranted, and coming. 

This was no small feat. Even arch dove Gertjan Vlieghe has managed to fall in line with the rest of the Monetary Policy Committee, commenting a few weeks ago that he sees one or two rate hikes a year. The unity on the panel underscores that moves in the key rate aren't just one-offs, the cycle is here. That's an impressive accomplishment, given that the U.K.'s going to depart the European Union in less than a year and there's no trade agreement in place. 

That, and some surprisingly decent economic data have lifted sterling, and should keep it from turning back down too far. Tuesday's report that the unemployment rate dropped to 4.2 percent, the lowest since 1975, is more than enough to fuel the BOE's paranoia that there's nothing even approaching slack in the labor market. The bank has fought hard to shift market perceptions and is not going back down if some some sluggish poor weather-related first quarter data pop up. 

But what is more important for future gains in sterling is the signal policy makers give in May as to when the next hike may come. Here, things aren't so stellar, so for the pound to break out of this range to $1.50 or anything like it looks really, really unlikely. The culprit, again, is the central bank. 

The drop in the PMI composite from its headier heights in October to 52.5 in March shows the U.K. is broadly losing momentum, and that is a serious drag on the outlook. The return of real wage growth was a long time coming, and it's hardly bonanza time for the British consumer. These hardly contribute to a slam dunk case for hiking rates.

What's crucial are the BOE's forecasts. Its most recent projections painted an inflation picture that was really not all that hot.

With stronger sterling it's hard to see how their update to their outlook next month could be anything but on the cooler side.

For an inflation-targeting central bank, faster rate increases are far from called for. In fact, it's hard to see how the "maybe two" hikes that Vlieghe suggested could come to pass in 2018. Forecasts for the November decision show investors are not yet on side -- they only see the probability of a quarter-point increase at just 45 percent.

True, sterling is back. But it isn't going anywhere fast.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

©2018 Bloomberg L.P.

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