3 September  2020: Sterling off its highs

Sterling off its highs

3rd September : Highlights

  • Bailey outlines risks of record level of uncertainty
  • Higher and longer. Greater Fed support to continue well into next year
  • Deflation for Eurozone a warning for the long term

Too early to say if the recent advance is over

BoE Governor Andrew Bailey gave his second speech in a week yesterday and this time he was in a no holds barred mood as he outlined just how difficult and uncertain the recovery from the Covid-19 Pandemic is likely to be.

Bailey warned that the UK is facing record levels of uncertainty as it faces up to the possibility that the recovery could take longer than expected and it is time for a sense of reality to kick in since growth could be far weaker than previously forecast.

The Monetary Policy Committee’s team of advisors gauge of uncertainty is at its highest level and the August prediction for a contraction in GDP this year of 9.5% could already be out of date.

The fear is that a contraction for the whole year of over 10% could be on the cards, despite the Bank’s assertion that it can and will provide even more support if that becomes necessary.

Another member of the MPC, Gertjan Vlieghe, was also singing from Bailey’s song sheet, commenting in a speech on uncertain times ahead. He is confident that employment will recover but the forecast growth for 2021 will still leave the economy around 5% smaller than pre-Pandemic levels.

Chancellor Rishi Sunak confirmed in an unlikely way that he is working on a programme of tax hikes as he was photographed on his way to a meeting with notes in his hand which said rises would not see horror stories, but there are difficult decisions to come.

The pound fell versus the dollar yesterday, but it is far too soon to say whether this is a profit taking correction following its recent rise or the start of a new trend.

It is interesting to note that as the market has returned to something approaching full strength following the August vacation period, that the greenback is staging something of a recovery.

Yesterday, the pound fell to a low of 1.3283, but on a volatile day, it recovered to close at 1.3351.

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Market view of the economy possibly too bearish

In terms of its own history, the predicted contraction in the U.S. economy has been of epic proportions but the market is coming to terms that it is not alone and by comparison, it may, despite several imponderables, perform better than other G7 nations in the medium term.

This has led investors returning from vacation to see value in the dollar index at its current level.

The predicted support at 92.20 has proved sufficiently strong to bring about something of a correction but as in the case of other currencies, it is too early to say what the short to medium term outlook is.

Analysts looking for clues will consider tomorrow’s employment report for August to be a potential turning point. It could be as simple as above July’s data good, below July’s data bad, for the market. In July 1.763 million new jobs were created with the predictions for August falling well short of that level.

Activity data released so far this week has been, on the whole, stronger than expected. This has led traders to believe that the U.S. has experienced its dip following pent up demand and it can now start to pull ahead.

Today’s release of weekly jobless claims will also be closely scrutinized. Over the period of the Pandemic, this data has taken on greater significance as more stable picture of employment since the NFP is often subject to significant adjustments

Initial claims are expected to fall below the one million mark, with continuing claims still holding around the fourteen million level but starting to show a trend lower after a few weeks where they appeared to plateau.

Yesterday the dollar index continued to correct higher. It rose to a high of 92.87, closing at 92.63.

Negative inflation a sign of the times

Several nations of the Eurozone including Germany and Italy fell into deflation last month as prices showed an average decline of 0.2% following a 0.4% increase in July.

While this in itself is of no great significance as a one-off, it perfectly illustrates the concerns over how fast and how strong the recovery in the economy is likely to be.

A contraction in prices in the services sector of 0.7% is a more concerning takeaway. It indicates that in a very competitive area of the economy, price cuts have begun in order for Eurozone firms to be able to compete and attract business.

The recent rise in the value of the euro versus the dollar has also put downwards pressure on inflation but given recent price action, the extremity of that rise may now be over, certainly in the short term.

The ECB’s reaction to poor data was fairly typical with analysts predicting it will choose to look past individual months data, preferring to concentrate on the bigger picture. It’s Ironic that they choose to do that since the reaction to improving data has been to laud it as continuing evidence that recovery is underway.

The next ECB meeting is a week today and it is hardly surprising that it is expected to lower its whole year forecast for inflation acknowledging that the data released yesterday won’t, in fact, be a one off.

However, the Central bank is expected to leave monetary policy alone, preferring to wait and see. As ECB Board member Isabel Schnabel said earlier in the week, as long as the economy meets their baseline scenario, further action is not necessary.

The euro retraced versus the dollar yesterday, falling to a low of 1.1822 and closing at 1.1854.

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.”