Sterling at Post-Referendum High

Pound rises 1.5% versus weakening dollar

Sterling reached another post-Brexit referendum high versus the dollar on Friday reaching 1.3737. It has continued to rally as Asia has opened, continuing the theme of last week and making a fresh high of 1.3770. The optimism surrounding the pound was brought about by a report, which has since been denied, that the Finance Ministers of The Netherlands and Spain have agreed to work together to ensure that, post-Brexit, the UK remains a close partner of the EU receiving preferential treatment. This preferential treatment could extend to favourable terms for membership of the single market.

There are two reasons for this move higher for the pound to be considered fragile; first, the two countries are only two of 27 and second, they are likely to be countered by Germany and France who favour far sterner conditions for the UK.

Inflation data will be released for the UK for December later this week and this is likely to have a major effect of Sterling moving forward. The pound has rallied by 2.3% over the past month from low to high and this should have a dampening effect on producer prices but will take a few months to feed through into CPI. However, analysts expect another rise in core inflation from 3.1% in November to 3.2% in December.

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Euro continues to rally in rate hopes

The single currency has continued its rally reaching a high of 1.2189 on Friday as the optimism over a tightening of monetary policy continues. It has continued to climb in Asia reaching a new high of 1.2241. It is clear from the minutes of the latest ECB Council meeting that its members are starting to openly discuss the need for a tapering of the Asset Purchase Scheme. This would still be pre-emptive since inflation remains benign across the entire region and would mark a significant change in policy.

Any further discussion of a tapering particularly involving ECB President Mario Draghi will mark a significant departure for the Central Bank and see the rally prolonged. The next major point of resistance for the Euro is at 1.2520 a level not seen since late 2014.

Inflation data for Germany will be released tomorrow, followed by Pan-Eurozone data on Wednesday. Germany is expected to see an unchanged rate of 1.6% while for the entire region it is expected to have risen from 1.1% to 1.2%. This is still significantly lower than the ECB’s 2% target but there is concern that it will accelerate later in the year as the rate of growth picks up.

Dollar index at fresh lows

The rallies for both the Euro and Sterling, each reacting to their own tailwinds, saw the dollar index which, tracks the value of the greenback against the currencies of six of its major trading partners, make fresh multi year lows on Friday. It is ironic that the rise in the Euro on the back of expectations of a tapering of the “additional measures” could, in fact, delay the tapering since the stronger currency will have a significant dampening effect on inflation.

The dollar itself is also facing the reality of a lowering of rate hike expectations. Inflation data released on Friday showed that while core inflation rose from 1.7% to 1.8%, it remains shy of the Fed’s target. Retail sales data for December was expected to rally but was unchanged both month on month and year on year. The effect of the December rate hike has yet to be seen which could slow consumer activity in January which is, anyway, seen as a “slow month”.

There is little in the way of significant data being released in the U.S. this week, so the dollar is likely to be reactive to news from Europe and the UK, with inflation the prime focus on both sides of the English Channel.

This week’s events of note

The first full week of the year, Politics could overshadow Data