Sterling Catches Perfect Storm

Market failing to price in Brexit Risk

The risks to the UK economy from the departure of the UK from the European Union, more specifically, the customs union and single market are being ignored by the market. It appears determined to take at face value the words of Bank of England Governor Mark Carney about the pickup in wage growth pointing to strength in the economy.

Evidence, some anecdotal such as Michel Barnier’s threat over the transition period not being a given or objective like the collapse of business investment are being totally ignored as Sterling breaks through long term resistance levels primarily versus a dollar which continues to weaken.

The pound also rallied versus the single currency yesterday reaching 1.1288 before falling back a little overnight. As the dollar index fell towards new multi-year lows (see below) the pound reached 1.4104 and has continued to climb overnight, reaching 1.4144 (0630 GMT).

The prospect of a rate hike in the UK remains very much in focus following last the inflation report earlier in the week and should next week’s employment report show growth in wage inflation, sterling could test the 1.4350 resistance as the post-referendum fall comes close to being completely retraced.

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Euro rise to bring growth concern.

The Euro broke through the 1.2520 resistance earlier this morning but has seen limited follow through as more selling has been seen close to 1.2550.

The current strength of the Euro is also a reflection of a weak dollar as sentiment turns against the greenback. Should the current rally break above 1.2580, the ECB will start to be concerned about growth continuing to develop in the weaker Eurozone nations. The economies of, for example, Greece and Italy have performed surprisingly well in the face of a currency that has rallied by over 20% in a little over a year. This is a new phenomenon in global economics and will need to be studied closely as there is no “formula” for ensuring that it continues.

One further macroeconomic factor that is likely to push the Euro higher is the improvement in employment. For the entire Eurozone, the unemployment rate has hovered around 9.5% for several months, but it is impossible to look at the region without using estimates which now blight he U.S employment report.

Using France as a proxy for the entire region, it is clear that jobs are being created and economic migration is falling. Unemployment in France has fallen below 9% for the first time in nearly a decade. Should this be repeated across the region, a perceived tightness in the labour market could fuel inflation.

Government debt concerns drive dollar lower.

There is little doubt that Donald Trump lives in the now. That is probably why the President is showing little concern over U.S. Government debt ballooning to over one trillion dollars. The Corporate tax cuts that have been passed will hit the fiscal receipts while an ambitious infrastructure programme will increase spending.

The dollar index hit a three year low of 88.54 yesterday and has continued to fall overnight as the Euro broke through major resistance at 1.2520. The low reached so far today has been 88.25.

Monetary policy loses out to fiscal concerns since the U.S. will rely on willing buyers for its increased debt and will be expected to pay more for the privilege by China and Japan, America’s largest creditors.

Since the disagreement in the middle of last month between President Trump and his Treasury Secretary over the preferred direction for the dollar, the greenback has lost close to 4%.

It appears to be an anomaly that despite the fall from a high of 103.82 in January last year to today’s low, inflation remains benign as this week’s unchanged number showed.