Under Pressure
Sterling has come under renewed pressure this week following the UK's new Prime Minister Boris Johnson's re-affirmation about the UK leaving the EU on 31 October with or without a deal. Furthermore, he has called for the abolition of the Irish backstop, while the EU insists the current deal is the only one available.
This, according to currency analysts, politics experts and indeed, common sense, can only lead to a hard Brexit scenario. And with that would follow, very swiftly, the doomsday scenario of a collapsed Sterling, chaos at airports and gridlock at ports for goods experts and imports.
Meanwhile, rate-setters at the Bank of England are expected to vote unanimously to keep interest rates unchanged at 0.75% next Thursday. While policymakers still talk of the likely need for gradually higher interest rates, there is no appetite to tighten policy until some of the fog of Brexit clears. Two of the most hawkish MPC members, Andy Haldane and Michael Saunders, recently indicated their preference to keep rates unchanged for now. Governor Carney will hold a press conference after the policy announcement at midday.
The BoE faces a potentially tricky task on how to present their new economic forecasts in the new Inflation Report, which will accompany the policy announcement. Its forecasting convention is to assume government policy for Brexit, which is for an EU deal, but that is becoming increasing inconsistent with market interest rates, also used in the forecasting process. No-deal risks have become more prominent in investors’ minds, partly reflected in markets fully discounting a 25bps reduction in Bank Rate over the coming year. In his first speech as PM, Boris Johnson said that the UK will leave the EU on 31 October, “no ifs or buts”. His call to renegotiate the deal to remove the Irish backstop, however, was met with resistance in Brussels. How the Bank gets round its conditioning conundrum is unclear. It could decide to adjust (raise) the conditioning assumption for market-implied interest rates or it could condition its economic forecasts on constant interest rates.
With the ECB shifting its bias towards more policy stimulus, but holding off from taking immediate action, next week’s focus turns to the US Federal Reserve (31 July), the Bank of England (1 August) and the Bank of Japan (30 July BST). The case for the first US rate cut for over a decade does not seem entirely convincing, especially with the labour market remaining strong. Nevertheless, policymakers are mindful of downside risks, including from weakening global demand. That partly explains the slowdown in US Q2 annualised GDP growth to 2.1% from 3.1% in Q1. Moreover, price pressures remain surprisingly subdued given that the US expansion is now the longest in history. An insurance rate cut of 25bps to 2.25% (the upper end of the Fed funds target range) is fully priced by markets, with a larger 50bps reduction being an outside possibility. Fed Chair Powell will hold a press conference at 19:30 BST, as usual, after the meeting. US labour market figures (Fri) are expected to remain robust. We look for Non-Farm Payrolls to rise 185k, a fall in the Unemployment rate to 3.6% (matching the near 50-year low) and for earnings growth to edge up to 3.2%. However, broader inflationary pressures remain well contained. We predict the Fed’s preferred Inflation measure, the Personal Consumer Expenditure (PCE) deflator, to rise to 1.6% from 1.5% and for the Core Measure (excluding food and energy) to edge up to 1.7% from 1.6%.
Following the ECB policy announcement this week deferring policy easing until September and a day ahead of the Fed decision, the Bank of Japan is expected to keep its policy settings unchanged. That includes leaving the short-term rate at -0.1%, its target for 10-year bond yields at around 0% and maintaining its purchases of government bonds and other assets. The focus therefore will be on updates to economic forecasts and whether policymakers decide to extend the date on the forward guidance beyond the current pledge to keep rates at ultra-low levels at least through spring 2020. In China, the focus will be on the official manufacturing and non-manufacturing PMI reports (Wed/Tue EST) and the Caixin manufacturing PMI (Thu/Wed EST). Australia will also release Q2 CPI figures (Wed) ahead of the RBA meeting in the following week. In the Eurozone, we will get the first indications for Q2 GDP and July CPI (both Wed). Our forecast is for Eurozone Q2 GDP growth to slow to 0.2% from 0.4% in Q1. France, Italy and Spain will also report preliminary figures. We expect firm numbers for France (0.3%) and Spain (0.6%), but flat growth in Italy. Our prediction for Eurozone ‘flash’ CPI (Wed) is for unchanged readings for both the headline (1.2%) and core (excluding food and energy) (1.1%) measures, well below the ECB’s inflation aim of close to, but below, 2%.
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.
