29 Nov 2018: Bank of England warns of No Deal Chaos

Bank of England warns of No Deal Chaos

November 29th: Highlights

  • May’s deal no nearer acceptance
  • Powell hints at rate hike pause
  • Weakening sentiment points to long-term woes for single currency

Carney sets out Brexit concerns

The Bank of England stress tests the financial solidity of the financial institutions it monitors on an annual basis. Following the 2016 Brexit referendum, the banks passed testing where a series of “doomsday” scenarios were used as the worst case; a sharp recession, unemployment at 9.5%, GDP contracting by close to 4.5%, and a collapse of the housing market.

Mark Carney, the Governor of the Bank of England, discussed this year’s tests yesterday and was at pains to state that the terms of reference used, despite being very similar to the 2016 ones, do not represent the Bank’s base case for next March, even though a hard Brexit is now becoming a real possibility.

The frenzy of analysis that has taken place this week as the Government released its view of the cost of Brexit based upon several scenarios have been used like a parent warning a child of the dire consequences of not brushing their teeth.

What has been missing in the analysis is the wider social effect of the “deal or no deal” decision that is facing the UK. It is more than a financial or economic decision; it affects the entire fabric of the country for generations to come.

It is almost impossible for the Government or opposition to be able to state its case any more clearly over what is going to happen on December 11th. The full extent of the future of the recently approved agreement is now being made crystal clear although it is hardly being helped by being labeled as the “best we could get” or the only deal available.”

In contrast to the referendum when all that were heard were the voices of Brexiteers as the remain camp firmly believed that the country would never vote leave, those against the deal are confident that it will never pass Parliament.

History has a strange habit of repeating itself, although in the words of just about every analyst currently, “this is not my base case”.

The pound remains in a range with traders unwilling to push it too far in either direction as the vote looms. Yesterday it traded in a 1.2728/1.2847 range closing at 1.2827.

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Powell finally complies with Trump’s view

The pace of rate hikes in the U.S. is set to slow in 2019 as the economy gets used to the rate increases that have so far been seen this year. The fate of the proposed hike next month is now far less certain following a speech yesterday by Fed Chair. Jerome Powell who commented that the Federal Funds rate is now close to neutral.

This sent the dollar index into something of a tailspin and saw a 600-point rally in equity prices.

The Federal Reserve guards its independence very closely but recent experience is that nothing appears to be outside the purview of the President who commented this week that he was “not a little bit happy” with either Powell or the FOMC. Most analysts tend to disregard the more extreme comments from President Trump although whatever the reasons for Powell’s comments he has apparently got his way.

Two members of the FOMC, the vice chairman Richard Clarida, and senior member James Bullard had boosted the dollar earlier in the week by supporting continued rate hikes. This adds some spice to the next meeting in the middle of next month although the minutes of the most recent meeting that are released later today should show continued harmony on the path of the Fed. Funds Rate.

The dollar index fell in the wake of Powell’s comments reaching a low of 96.69 and has remained under pressure overnight.

Euro facing structural concerns

The influential IFO institute in Munich released its index of business sentiment earlier in the week and it showed a decline for the third month in a row. There are starting to be concerns in the Eurozone about the model to which the ECB complies to ensure the success of the growth and stability pact. This in turn leads to the return of the age-old question “does one size really fit all” when it comes to monetary policy?

Monetary policy in the Eurozone has been accommodative for as long as most people can recall but the region’s largest economy cannot grow and slipped into a decline in the most recent quarter.

Mario Draghi may say that he isn’t concerned about the data from individual countries and that his mandate is to create growth and stability across the entire region. That places him in a minority of one in the current environment since the Eurozone is too young and immature for the whole to be viewed without a consideration for the individual nations.

The immediate future the region is a worry for the ECB since it has very few policy tools to enable it to pull the economy round. The currency has weakened by 10% from high to low versus the dollar this year yet exports have not really seen any growth. Inflation is starting to concern Germany and a continual fall in the value of the currency will exacerbate that issue.

Brexit is seen as a uniquely British issue but the effect is doubtless being felt across Europe’s supply chains and that will create further uncertainty going forward.

The single currency rallied against a weakening dollar yesterday reaching a high of 1.1387 although based upon its own merits a long-term structural decline remains in place.

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.”