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Pound power: How Mark Carney is changing the world

Mark Carney, governor of the Bank of England.
Simon Dawson | Bloomberg | Getty Images

Here's the power of a central banker's words: "There's already great speculation about the exact timing of the first rate hike, and this decision is becoming more balanced. It could happen sooner than markets currently expect."

That was Bank of England Governor Mark Carney on Thursday during his annual Mansion House speech.

The market reaction was fast and furious. Sterling spiked, hitting 1.70 against the U.S. dollar for the first time since August 2009. The currency has gained more than 9 percent this year, making it the star performer among the currencies.

And according to strategists, there's no stopping it now that Carney has broken from the pack of major central banks and changed the story line.


European markets close: Mark Carney speaks

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Many factors affect currency values, including geopolitics, growth and other economic data, mergers and acquisitions, politics, and central bank reserves. But none is more important and powerful as interest rate differentials. And with those magic words, Carney has set the trade.

"It is likely that pound strength will prove more persistent now with the BoE highly likely to become the first major central bank to begin raising rates later this year," wrote currency strategist Lee Hardman of Bank of Tokyo Mitsubishi

Put simply: "In the short run, U.K. data is better and Carney sounds more willing to raise rates early than (Federal Reserve Chair) Janet Yellen. There isn't much point fighting the move," said Kit Juckes of Societe Generale.

Before Carney's speech, the market was pricing in a hike in interest rates from the Bank of England next May; after the speech, that moved up to January. And some are talking about as soon as this year.

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"The market had between pricing in one interest rate hike in the next 12 months, and this has jumped to an 80 percent chance of two hikes," said Camilla Sutton, Chief FX strategist for Scotiabank.

What's driving Carney's shift?

The British economy has surprisingly gained steam.

GDP expanded 0.8 percent in the first quarter, and the U.K. is set to be the fastest grower among G-7 countries this year.

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"Growth has been much stronger and unemployment has fallen much faster than either we or anyone else expected at last year's Mansion House dinner," Carney said in the speech.

Carney did signal that the interest rate increases will be "gradual and limited" to keep enthusiasm tempered a bit, but the hawkish message had been received.

Charlie Bean, deputy governor at the British central bank, told the Sunday Times a rate increase would be a sign that Britain "is on the road back to normality … as a demonstration the economy is healing."

The next test for the currency is the release of minutes from the last monetary policy meeting, due Wednesday.

"The tone of the debate is likely to shift in terms of economic slack and timing of the first hike," Brown Brothers Harriman strategists led by Marc Chandler said in a note.

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"However, the market reaction to the minutes will likely be most dramatic if there is a dissent. Sterling would likely rally, and short-term interest rate futures would sell off (higher interest rates). A dissent would likely fan speculation that the first rate hike could take place before the end of the year. "

What's most unusual about the shift in tone and policy is that other central banks around the world are still engaged in competitive devaluations—policies intended to weaken currencies, or at least with an indirect and welcome side effect of weakening currencies. Those policies include quantitative easing, low interest rates, and promising easy monetary conditions. Having a weak currency these days is considered a blessing—mainly because it helps stimulate exports and much-needed growth. Also, a stronger currency could exacerbate deflationary fears, which is part of what has the European Central Bank worried.

So why is Carney not afraid of a stronger pound?

"The pound got very cheap after the global financial crisis, so a lot of what is happening now is a big reversal. And it's not expensive yet," said Jens Nordvig, head of forex strategy at Nomura. "That is why Carney is not overly concerned, and because the U.K. has less deflation risk than others"

What's striking here is the policy divergence among the major central banks, with the ECB recently announcing a series of easing steps including negative deposit rates, the Bank of Japan fully engaged in aggressive QE, and the Federal Reserve, while in tapering mode, still talking super-low rates and easier policy to fight weakness in the labor market and slack in the economy.

Read MoreEconomists say theFed is wrong about growth

Some are speculating that the Fed, with an eye on policy normalization and an improving economy, may follow the Bank of England's lead.

"The surprise BoE Mansion House speech may increase the degree to which investors look to (this) week's FOMC as a guide to whether the Fed sees itself beginning the road to normalizing policy or engaged in an ongoing effort to avoid normalization for as long as possible," Citigroup's Steven Englander said in a note.

But Englander's conclusion is that "the FOMC and Janet Yellen will maintain their highly dovish stance, so the BoE shift increases the (U.S. dollar) downside next week."

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But the real winning currency trade here may be bettering on the pound against the euro, with the two central banks blatantly thinking about and moving in divergent paths.

Already the euro is at the weakest vs. the pound in 20 months.

But strategists say there's more room to run, because the central banks are now—for the first time since before the financial crisis—blatantly moving in opposite directions.

—By CNBC's Sara Eisen