18 Jan 2019: Sterling rallies as Brexit delay looms

Sterling rallies as Brexit delay looms

January 18th: Highlights

  • EU will agree to delay but not no fresh negotiations
  • Eurozone inflation remains below ECB target
  • Dollar rebound will need further stimulus

May making little progress towards Plan B

Donald Tusk, the President of the European Council, has hinted, in the wake of this weeks two momentous votes in the UK Parliament, that Brussels may be open to a delay in the implementation of Article Fifty of the Lisbon Agreement.

He stressed that the EU will not reopen negotiations over the future relationship but could agree on a delay to allow the UK to find common ground between MPs that will allow an orderly departure to follow.

UK Prime Minister Theresa May met with senior Parliamentarians yesterday to discuss where consensus could be found but, crucially, Opposition Leader Jeremy Corbyn continues to refuse to meet unless Mrs. May agrees to take a no deal Brexit off the table. This is being seen a little more than a ploy to increase the pressure on the Government since Mrs. May cannot guarantee no-deal as it remains the default legal position should no consensus be found or agreement reached.

The FX market has performed an almost 180-degree reversal of its view of Sterling, now considering the risk to be to the upside. No deal, which would be considered the worst of all worlds financially, is now considered to be highly unlikely as there is no majority in favour in Parliament. Any delay in triggering Article Fifty is expected to provide more time to reach an agreement on a softer Brexit although it is impossible that a softer Brexit than the agreement which was tossed out by MPs this week could be agreed.

Sterling rallied to a fresh two month high versus the dollar on renewed optimism over Brexit reaching 1.3001 and closing at 1.2988. It has also rallied against a weaker single currency reaching a high of 1.1411.

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Eurozone inflation confirms lack of price pressures

Pan-Eurozone inflation data was released yesterday and confirmed what the market had expected; that there are no upwards pressures on prices as economic activity continues to falter.

While the Eurozone remains well short of the official definition of a recession which is successive quarters of contraction of GDP, by several measures it is technically in a recession already. While it remains difficult to judge the region as a whole due to the contrasting economies which make up the Eurozone and the ECB’s dogged determination to consider it as a whole there are more and more individual economies which are starting to struggle.

It is worth noting that those are predominantly the larger economies like Germany, France, Italy, and Spain. Each has its own reasons for contraction which add to the question over “one size fitting all “ economically.

As the Eurozone reaches twenty years old, questions continue to be asked about the restrictions that have been placed upon the weaker nations ability to grow. Traditionally countries like Portugal, Italy, Ireland Greece, and Spain, the so-called PIIGS, would have devalued their currency and despite rising inflation would have started to grow and trade their way out of recession. That luxury is no longer available and they have to try to exist in the austere conditions that have been forced upon them by Brussels and Frankfurt.

This vicious circle is likely to remain until the PIIGS completely change their economies or one starts what could become a cascade of departures as Italy has already threatened. Even as the region matures it continues to face the same difficulties which will lead to a weakness in the currency.

Yesterday, the euro fell versus the dollar to a low of 1.1370 although it recovered to close the day unchanged at 1.1391.

The dollar needs stimulus to continue any rally

A couple of weeks ago the dollar index fell to test significant support at 95.02, which was a three month low, close to the greenback’s 200-day moving average. Since then it has started to climb again due, in no small part, to the continued weakness of the single currency which alone makes up more than 55% of the index.

In order for the rally to continue to the dollar will need to find further economic support, particularly since the prop afforded by a growing interest rate differential no longer exists.

Traders are already starting to look towards the employment report for January which is still two weeks away. Having seen a significantly better than expected number of new jobs created in December, the risk is for a revision lower and should the January data be weak or even close to market expectation around +180k, the dollar may suffer even if wage inflation remains above 3%.

Industrial Production and Capacity Utilization data will be released today with analysts expecting production having fallen from December’s relatively strong 0.6% to 0.2% in January although Capacity Utilization is expected to be unchanged at 78.5%.

As the U.S. economy slows to a more manageable rate of growth at or just below 3% and the Fed takes a more reactive stance, the dollar index is likely to settle at or close to the support at 95.02. Yesterday it was virtually unchanged on the day, closing at 96.09 having made a low just below 96.00.

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.”