Daily Market Brief 18 June 2018

Dovish MPC to push Sterling lower

June 18th: Highlights

  • Interest rate differential continues to widen
  • Euro finding support despite mounting headwinds
  • Tit-for-tat trade tariffs slow dollar rise

Central Bank still stuck in the middle

The Monetary Policy Committee of the Bank of England meets this week. Following last week’s meetings of the Federal Reserve and European Central Bank they are certain to imitate the stance of the ECB by keeping rates on hold. There will be the two “usual suspects” who will vote for a hike, but it would be a major surprise if the vote were anything other than 7-2 in favour of no change.

The Bank is caught in the middle of the Brexit dilemma as the economy continues to slow and the currency falls, but inflation appears to have bottomed well above the Government’s 2% target.

It is incredible to consider that two years after the Brexit referendum the two main political parties are unable to even agree internally on their policy regarding the UK’s departure from the EU and this is a cause of a great deal of instability in both the economy and for the pound. The debate on procedural matters continues in Parliament which detracts from the Government’s ability to produce a set of proposals for the future relationship with the next EU summit looming.

The pound remained weak all day on Friday, trading as low as 1.3211 before closing virtually unchanged at 1.3278.

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Euro struggling to make progress but downside solid

ECB President Mario Draghi is probably secretly delighted with the continued fall in the value of the single currency as he sees a lower euro as a way of ensuring growth in several of the weaker Eurozone economies.

It was hardly a surprise that the ECB was in a dovish mood at its meeting last Thursday as there is very little reason presently for them to consider a hike to short term rates as the economy faces several headwinds.

There is still concern over the amount of bad debt that remains in the balance sheets of the banks. This could mean that even larger institutions like Deutsche Bank are looking to withdraw from a number of markets and concentrate their business closer to home.

The economy is starting to slow with Purchasing Managers indexes predicting a fall in manufacturing and industrial activity.

Overall, the ECB’s policy appears to be correct considering the current level of activity. It is entirely sound that they withdraw the extraordinary accommodation and while it is unusual for a Central Bank (particularly the ECB) to give such a long-term view, it is also clear that the ECB will not be able to follow the FED and hike before next summer. This is probably a ploy to ensure currency weakness without incurring the wrath of President Trump’s team of currency manipulation inspectors.

The single currency remained close to its recent low on Friday as markets continue to react to Thursday’s press conference. It reached a low of 1.1543 before creeping higher to close just above 1.1600.

Dollar struggling to move higher as trade concerns return

There were two entirely predictable developments in the growing trade war between China and the U.S. on Friday. First, President Trump decided to enact tariffs he had announced on the import of around fifty billion dollars’ worth of products from China and, second, China retaliated by enacting its own tariffs on 659 U.S. products that they import form the U.S.

Net effect? Zero!

President Trump is clearly both learning the “diplomacy game” and also living in the past if he really believes that a little “sabre rattling” over trade will cow the Chinese into accepting more U.S. imports to balance American trade deficit.

Now, the U.S. importers will try to find cheaper alternatives but will still import and the Chinese will act similarly. The only way the U.S. will cut its trade deficit is for them to produce more of what they need at home. China’s economy has a trade surplus and will continue to do so until domestic demand rises and more of what they produce is consumed at home. Economics 101!

The dollar had a strong week last week driven by the hike in short term rates but more significantly by the fact that the Fed is now likely to hike twice more this year. The second of those hikes will probably come around the time of the midterms, which is a departure from the usual practice of deferring hikes during elections.

The dollar index consolidated its recent rise on Friday but is unable to break through the 95.00 level. It closed at 94.80 and has remained close to that level as the Asian week has begun.

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.”