Sterling stabilizes but the outlook is bleak
July 12th: Highlights
- Trade deal with the U.S. in jeopardy
- Dollar continues to do the Powell Hokey Cokey
- Eurozone data to determine short term direction for the single currency
Branson predicts parity if no deal
Richard Branson, Head of the Virgin Group, predicted yesterday that should a no-deal Brexit happen in October, the pound would collapse to parity versus the dollar. Were that to happen over a very short period, the inflationary effect would be such that the Bank of England may be forced into a rate hike. That could be devastating in an economy that is certain to be struggling for any growth and would lead to a long and potentially devastating recession.
There is currently a view among analysts that the Bank of England is likely to cut rates by 25bp in November as something of a post-Brexit precaution. That will to add momentum to the pound’s expected weakness.
Chancellor of the Exchequer, Philip Hammond expressed concerns, in an interview yesterday, that France could use customs checks on goods entering and leaving France to and from the UK as a political tool which would lead to shortages of many imported goods. This may prove to be impossible to put in place since it would badly affect the output of those EU businesses whose supply chains will already be pressured by Brexit.
Either way, the raising of the issue highlights the likely chaos that will ensue between the probable confirmation of Boris Johnson as Prime Minister in the next few weeks and the end of the year, with Brexit, however it happens, in between.
Yesterday, the pound rose to a high of 1.2571 versus the dollar although it fell back to close at 1.2520 as the greenback was affected by the “will they won’t they” scenario over short-term interest rates. Against the single currency, it also rallied, reaching 1.1153, closing at 1.1128. However, it is still likely to close the week lower for the tenth consecutive time.
Powell determined to keep markets guessing
Traders appear to have “cottoned-on” to the comment of Fred Bullard a senior member of the FOMC and President of the St. Louis Federal Reserve, that the Fed should cut later this month as an “insurance” against a likely weakening of the economy not least due to uncertainties over trade and the global economy.
In his testimony, Powell alluded to concerns over the global economy but his FOMC colleagues appear to have mixed feelings about rate cuts. Bullard was joined by New Your Fed Chief, Lael Brainard in calling for a rate cut while the Presidents of both the Atlanta and Richmond Feds, having polled local businesses, see the economy as “humming along very nicely”.
While the odds favour a cut at the meeting that concludes on July 31st, it is by no means certain despite the interest rate futures continuing at 100%.
Part of Brainard’s reasoning was that inflation remains well below the Fed target of 2%. However, data released yesterday showed that inflation in June was higher than market expectations. In the long run, if the Fed is deciding that a cut is necessary to protect future growth then it would take a run of higher inflation data to have any significant effect on the rest of its thinking.
Yesterday, the dollar index fell to a low of 96.79 although it did really a little to close at 97.08.
Euro bulls hoping for an improvement in data
However, the markets had been expecting that the heading off of a recession would be due to some affirmative action from the Central Bank rather than the “hope and pray” mentality that has been used due in no small part to a lack of options.
While political machinations have taken the spotlight away from economic activity, in his last few months in office, Draghi will want to create his legacy as something other than the Central Bank Head who over eight years presided over an economy that was never strong enough to see a rate hike.
While Sr Draghi has done more than simply state that he would “do what it takes to save and protect the euro”, he has managed to ward off, on several occasions damaging slowdowns due in no small part to the effect of the structural makeup of the region rather than any monetary policy miscalculations on the part of the Central Bank.
Yesterday’s release of the minutes of the latest ECB meeting held no surprises. The consensus is that the economy is performing as expected and no major movement in either direction is likely until there is a pickup in the global economy.
Today sees the release of industrial production data for the entire region which will show an improvement month on month rising from -0.5% in May to +0.2% in June. However, year on year is still going to show that production is slowing.
The euro remained reactive to the drivers of the dollar yesterday, reaching a high of 1.1286 but eventually closing two pips lower on the day at 1.1249
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.”