Buckle Up For The Ride
Last week capped another week of straight losses for Sterling. An 11 week losing streak to be exact. And in the first half the week, that trend seemed set to continue - especially as the key fundamentals - the quantifiable determinants, if you will - of the exchange rate; such as Brexit politics, interest rates, inflation and growth remained unchanged.
Well, so far so predictable, right? Wrong!
On Wednesday, rumours started circulating of a likely interest rate cut by the ECB and Sterling rallied half a cent against the Euro. Thursday saw more life breathed back into the pound and and if the trend continues, it is possible that Sterling could end the week higher than where it closed last week - a level that it has just surpassed at the time of writing.
For some time, markets have been impatiently awaiting two things – the outcome of the Conservative Party leadership election and the July Federal Reserve policy meeting when the US central bank is expected to cut interest rates. On Tuesday we should get the confirmation of the first of those, while the Fed’s announcement is scheduled for the following Wednesday. Boris Johnson is still seen as odds-on favourite to be confirmed as the new Tory Party leader and the next UK Prime Minister. As his official appointment as the latter, however, will not come until Wednesday that may be too late for him to address the House of Commons before it recesses for the summer on Thursday. If so his first appearance before the Commons will be delayed until it reconvenes in early September. Brexit will obviously be the dominant immediate issue for the new PM. With a Johnson win probably already almost fully discounted that outcome may have little initial impact on markets. However, markets will be looking for early indications on his plans for negotiations with the EU. Media reports already suggest that Johnson will transfer responsibility for Brexit talks to the Cabinet Office with the Brexit department now set to concentrate on ‘no-deal’ planning. The coming week’s UK data calendar is sparse. Tuesday’s CBI Industrial Trends survey will provide the latest update on the factory sector. Like their counterparts elsewhere, UK manufacturers have been under pressure due to uncertain global conditions as well as pressures closer to home. It is unlikely that the July survey will show much respite. The CBI will also release its July retail survey. After a much stronger-than-expected bounce in the official retail sales measure Thursday’s reading will provide the first indication of whether this strength has continued into July.
This week’s stronger-than-expected June readings for both retail sales and manufacturing output added to the series of positive US data surprises seen since the June Federal Reserve policy meeting. However, that has done little to change markets expectations that the Fed is likely to cut interest rates at its upcoming policy meeting on the 31 st July. A move is seen as a near certainty by markets and the only doubt is the size of the reduction with the chances of a cut of 0.5% points now seen as having a significant probability. The market’s confidence reflects the recent comments from Fed officials which, with a few exceptions have played down the significance of recent data and continued to point to the likelihood of a July cut. From this weekend, Fed policymakers will go into their ‘purdah’ period ahead of the meeting. Friday’s first estimate of Q2 GDP is forecast to show 1.8% annualised growth, down from 3.2% in Q1 and equal to the lowest quarterly growth rate since early 2016. That outturn may add to concerns that the US economy is losing momentum. However, the detail of the report is likely to show firm final demand growth due to a rebound in consumer spending after a weak start to the year. So the slowdown seems to primarily reflect weaker stockbuilding and as such should be transitory. Aside from this the US data calendar is light but updates on housing purchases and on factory orders will be of interest.
Ahead of the US Fed meeting, next week’s European Central Bank update is likely to see another central bank adopting a more ‘dovish’ monetary policy stance. At its last meeting the ECB signalled growing concerns about downside risks by changing its forward guidance on policy in a dovish direction for the second time in 2019. At that point, it merely signalled that it was likely to wait longer before raising interest rates. However, a few weeks later a speech from ECB President Draghi upped the ante by hinting at the possibility of an easing in monetary policy. With Eurozone economic growth still very sluggish and inflation well below target markets are now looking for signs of a near-term easing in policy from the upcoming meeting. The market expectation for now seems to be that while an immediate policy move is not out of the question the more likely outcome is that this time the ECB will just pave the way for potential easing in September. This is likely to be conveyed through another change in its forward guidance. The current guidance makes no reference to lower rates, so to signal a risk of a rate reduction analysts expect the ECB to change it to say that rates will “remain at their present or lower levels at least through the first half of 2020”, a formulation that has been used as a signal in the past. It may also move the date further out (or even remove it altogether). Interest rate cuts are seen as the most likely tool for any further policy easing, while a ‘tiering’ of interest rates is reported to also be under consideration. In contrast there is thought at least for now to be a higher hurdle to resuming net asset purchases. Before the ECB’s announcement, the July Eurozone ‘flash’ PMIs and the German IFO survey will both provide timely updates on current economic conditions in the region. Both surveys pointed to sluggish growth overall in the first half of the year, with a marked divergence between a particularly weak manufacturing sector and somewhat brighter picture in services. Analysts expect the July readings to be little changed from June suggesting that the situation is stable for now but that growth remains subdued.
See you next week! To discuss how the above may affect you, please contact your Currency Dealer at Heritage Pay on +44 (0) 203 858 7274.