Bank of England to raise rates next year

July was a good month for GBP which was the best performing G10 currency surpassed only by the USD. Both currencies shared a common theme last month, namely that their respective central banks both reaffirmed the commitment to hike rates in the coming months. The result has seen GBP out-performance primarily versus the commodity currencies whilst EUR/GBP finally dipped below the 0.70 level which had stubbornly held in recent months. Despite another soft inflation reading, the recent upturn in average earnings data has continued, making this data series one of the most significant drivers for the currency. This has prompted a more sustained hawkish tone from the Bank of England with Governor Carney most explicit in his assertion that the debate on tightening would come into sharper relief at the "turn of the year". 

"Our economists continue to look for the first rate hike in February 2016 and a gradual path thereafter. We continue to focus our bullish GBP strategies via the crosses, where the policy divergence theme is at its strongest," notes BofA Merrill Lynch.

The most pervasive driver for the pound will remain the outlook for UK interest rates. GBP has historically continued to perform well even after the start of a tightening cycle. The fact that broader market positioning is not currently an impediment to GBP upside combined with a relatively benign profile for UK rate hikes next year is reassuring. 

"EUR/GBP has bounced impressively from its 0.6936 set in July low but with our European economists raising the possibility of further ECB action, perhaps as early as September, we reaffirm our year-end target of 0.67," added BofA Merrill Lynch.