Sterling Facing Bleak Winter

Consumer reining in spending

Two reports issued so far this week in the U.K. highlight the concern that the consumer is beginning to feel the pinch of the fall in real wages as inflation continues to rise and wage increases fail to keep pace.

Yesterday’s retail sales data showed that like for like activity fell by 1% in October, the largest fall since 2008. New Car registrations are also weak falling by 12.2% although this data followed seasonally high registrations in September as the “new registration” was released.

Following last week’s fall for Sterling, as the realization dawned that despite the first rate hike in ten years, the Bank of England is extremely concerned about the prospects for the economy and the ongoing effect of Brexit, any rally has attracted sellers.

The post hike highs of 1.3300 and 1.1407 versus the dollar and Euro are providing very strong resistance. Yesterday the pound fell following the release of the retails sales data and remained weak all day. The pound’s fall is most stark against the dollar as the Euro faces its own issues centred around monetary policy. The strong support for the pound around the 1.3000 level will only remain while optimism about the Brexit talks which resume tomorrow remains in place.

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EU Commission set to get tough despite optimism

With the resumption of Brexit talks tomorrow the general feeling of optimism and “no news is good news” sentiment is likely to be tested to its limit as the EU negotiators will receive the green light from the EU commission to “play hardball” as several individual states see merit in making Britain wait for a deal which could lead to acquiescence over the budget contribution.

The transition deal is likely to be all encompassing with the U.K. expected to contribute to the various EU programmes rather than simply “cherry picking” membership of the single market while allowing businesses to adjust to life on the outside. In particular, the EU will not allow individual deals to be negotiated while membership of the single market remains.

If these are the conditions imposed in order for stage two to start next month, Theresa May will face a very difficult task convincing some of the more hawkish members of her Cabinet and the “no-deal” rhetoric could return.
The EU still expects concessions over the “divorce bill” despite Mrs May promising that the U.K. would fulfill its financial commitments. This is typical of the U.K.’s stance over a number of issues, that has irked the EU. The time for veiled promises is rapidly coming to an end and needs to be replaced by firm commitments if Brexit isn’t going to end in the complete disaster feared by remain campaigners.

Euro at lowest in three months on diverging monetary policy

The single currency fell to its lowest level in three months versus the dollar yesterday reaching 1.1554 as traders railed against the increasing cost of funding long euro positions. The effect of diverging monetary policy is making a comeback as a major driver of currencies as Central Banks react to the differing pace of recovery and growth in their respective economies.

Going forward into 2018, the effect of interest rate differentials is likely to grow with the ECB and BoE very much in a holding pattern and the FOMC likely to raise rates at least three times provided the economy continues to grow as it has this year and the conundrum of benign inflation can be solved.

The Bank of England signalled only two 25bp hikes can be expected in the next three years as Brexit continues to take its toll on both activity and sentiment, while the ECB President remains concerned about the sustainability of growth across the whole EU. There are some voices of concern among the ECB council members but until inflation starts to get closer to the 2% target, Mario Draghi will hold sway.

The major support for the Euro is at 1.1280 and it is probable that the influence of the dollar will be the driver to push the Euro lower rather than any developments in the Eurozone.