The outlook for sterling is finely balanced between two countervailing forces.On one hand, there is plenty of room for the market to price a more aggressivehiking cycle. The MPC has done an excellent job of keeping rate expectationsanchored in mid-2015 since they abandoned forward guidance, but this is nowstretching credibility. Today’s labor report, where the u/r fell through theoriginal 7% threshold (the monthly number reached 6.6%!) is a case in point.Inflation has been weak, but the market should see through headline CPI towages, which are rising. As well as a more meaningful gauge of medium termprice pressures, higher incomes will help mitigate the impact of rate rises onthe housing market. The greater importance of wages is illustrated by chart 1,which shows sterling to have tracked real wages well over time.
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