Binary Bets of the Week: How Soon Will Interest Rates Rise and the Mighty Kiwi

by Dave Evans of binary.com

How Soon Will Interest Rates Rise?

Bank of England governor Mark Carney put a rocket under the British pound in his Mansion House speech on Thursday. The key message was: “This decision [to raise interest rates] is becoming more balanced. It could happen sooner than markets currently expect”.

Markets had already been pricing in a rate hike by 2015 and building up to a 2% rate by 2017, but yesterday’s announcement caused many to revise their expectations and speculate on an early 2015/ late 2014 rate hike. Quite how large this rate rise might be is unclear, especially with other central banks now making ‘baby steps’ with 0.10% incremental changes instead of the regular 0.25%.

Historically, these baby steps may seem trifling in comparison the heady days of the 70s and 80s where rates hovered around the mid-teens.

UK Interest rate from 1975

The longer term average for UK interest rates is around 5%, with 2% the general floor seen in periods of trouble such as the second World War. MPC member Weale summarised the situation as follows:

“I hope people do realise that a bank rate of half a per cent is not in any sense a normal state of the world”

So interest rate rises are going to happen, but the Bank of England and Carney know that they will have to tread very carefully. Any recovery is fragile, especially while parts of Europe struggle with high levels of unemployment. Carney’s Mansions House speech caught many on the hop, but shrewd market watchers were anticipating something significant.

The key question is whether markets now have further rate hikes fully accounted for. Carney’s speech may have shifted expectations forward slightly, but in theory at least, the current price of the GBP/ USD should reflect the probability of near term interest rate increases. Therefore anyone betting on the pound now is not really betting on a rate hike, but a rate hike that comes sooner or greater than expected.

The latter is unlikely especially with the danger of a large rate hike jolting the economic recovery out of its groove. What is more likely is a smaller rate increase sooner than expected and in this, Carney could be taking a leaf out of the ECB’s book and make tiny changes to policy. A 0.1% rise isn’t out of the question.

GBP/ USD Monthly Chart

As the chart above shows, the GBP/ USD is ready to test the overhead support levels in place since 2009. While Carney’s Mansion House speech may have caught some on the hop, the rapid reaction seen on Thursday arguably overshot in the other direction. Any early interest rate hike is likely to be small and could even by a ‘micro’ hike of around 0.1% to test the water.

Therefore, there could be some downside, not upside potential over the coming month as traders reset their expectations. A good way to play this is an In/Out trade betting on rangebound trading for the GBP/ USD with an upside cap. An In/Out trade predicting that the GBP/ USD will close between 1.7000 and 1.6800 on July 14th 2014 could return 172%. This equates to a return of £17.20 from a £10 stake.

Of course, currencies come in pairs so a rise in the pound could cancelled out by a rise in the US dollar, but right now, the US administration is showing no signs of following the UK in increasing its interest rates.

The Mighty Kiwi Flying High

One nation making no bones about increasing its interest rates is New Zealand, which now has the highest rates in the developed Western World at 3.25%. The New Zealand economy has benefitted from the commodity boom, but unlike its neighbour Australia, has not experienced the same pain as this trend diminishes.

Indeed, New Zealand has recently been outpacing its Western rival with GDP increases above 2%. In addition, since the back end of 2009, there has been just one quarter of negative growth (and just -0.2% at that!).

The recent interest rate hike saw the NZD/ USD shoot up on the week.

NZD/ USD Daily Chart

Indeed, looking at the monthly chart, we can see that the Kiwi is heading right back towards the pre crisis highs.

The NZD/ USD could have some gas in the tank to revisit those highs in the next couple of weeks, making a ONE TOUCH trade look attractive. This means you win if you hit your target level within the specified time frame.

A ONE TOUCH trade betting that the NZD/ USD will TOUCH 0.8775 at some time in the next two weeks for a potential return of 241%. This could return £24.10 from a £10 stake.

Disclaimer: This trading guide is intended for educational and information purposes only. They should not be construed as giving investment advice and you should not rely on any content within these guides in making or refraining from making any investment decisions. Binary.com accepts no liability whatsoever for any losses incurred by users in their trading. Fixed odds trading may incur losses as well as gains.