03 Oct 2018: Government cracks widen driving Sterling lower

Government cracks widen driving Sterling lower

October 3rd: Highlights

  • Pound at three-week low despite vague border claims
  • Brussels worst nightmare; an Italian National Currency
  • Dollar upside flame continues to be fanned as it closes on resistance

Brexit: No deal may be only deal

Sterling reacted to rumours that the Conservative Party Conference, being held this week, is not running smoothly. It breached the 1.3000 level versus the dollar for the first time in three weeks and with Market sentiment shifting more towards hard Brexit as the most likely outcome, there is downward pressure on Sterling.

Much of the shift in sentiment surrounds the Irish Border. It is hard to imagine any solution that doesn’t involve a massive concession from one side or the other and it is hard to see either side prepared to make the first move.

The leader of the Democratic Unionist Party, which props up the UK Government, underlined their position again yesterday; Northern Ireland must leave the EU on the same terms as the rest of the UK. But the idea of a “border away from the border” has been viewed by many as a bit of a fudge as it would involve the use of “equipment not yet invented”. Market sentiment is shifting from the expectation that a deal will be done, towards hope that one can be done.

The pound fell to a low of 1.2941 and closed at 1.2978 versus the dollar. It continued to fare a little better versus the single currency, although it gave back all of yesterday’s gains making a low of 1.1218.

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Italian “luncheon vouchers” become a possibility

It is a rule of the Eurozone that national governments are not allowed to guarantee a national currency and remain a member of the single currency.

During the recent election campaign in Italy, the nationalist/populist parties described a method by which they could introduce a national currency that had an implicit rather than an explicit guarantee., The reasoning was that if the Treasury issued a series of “tokens” that were exchangeable only within the country and only to pay nationalised utilities then a guarantee would not be necessary. For example, an employee would receive a certain value of “vouchers” as part of his salary and with those he could pay for gas, electricity, and water. This would not impact the Italian debt to GDP ratio and allow the Government to spend more on welfare and tax relief.

This notion was pretty much ignored by Brussels until yesterday when the idea has been resurrected by the new Government. Claudio Borghi a nationalist within the Government ranks said that most of Italy’s problems could be solved by the re-introduction of a national currency.

His radical theory was immediately played down by Prime Minister Giuseppe Conte who said that the euro is un-renounceable (sic). However, a national currency running in parallel for national use only is feasible.

Borghi is the economic head of the National League which is in coalition with the Five Star Movement.

For now, this is a war of words but should Italy become serious about its ability to thrive outside the Eurozone then it may be a blow too many for the single currency.

The euro fell to a low of 1.1505 but rallied a little to close at 1.1547, as day traders took profit on short positions.

Dollar rally closing on strong resistance

The greenback has taken on the mantle that was being carried by the euro earlier in the year by becoming the reactive currency to the woes that are facing its G7 counterparts.

There is strong resistance not too far away following its recent rally, and it may take a little more than negativity towards the euro and pound to push it through.

The dollar continues to benefit from the relative strength of the U.S. economy and the actions of the Federal Reserve, which are likely to hike once more this year and three more times in 2019 closing out this sequence with one hike in 2020 with the Fed Funds rate reaching 3.5%

There are several matters outstanding which could lead to a correction for the dollar. First are the upcoming midterm elections in which it could be that President Trump fares extremely badly giving Democrats enough seats to stage impeachment proceedings.

Meanwhile, the GDP data for Q3 while relatively strong won’t reach the heights of Q2 when growth was 4.2%. It is expected that growth will be between 3.2% and 3.5%, enough to see rates continue to rise but at a slightly slower pace than had been anticipated in the short term.

The dollar index reached a high of 95.74, just short of resistance at 95.80 and closed at 95.50.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”