Sterling on the back foot

15th October 2018 Market Update

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?? GBP - Sterling has started this week firmly on the back foot, as Brexit headlines continue to dictate the fate of the currency as negotiations stall. The main issue appears to be that of the Irish backstop as this weekend, Dominic Raab was forced to make a last-minute trip to Brussels to explain to Michel Barnier that due in part to political instability in the UK – a deal was unlikely to be struck today. Indeed, the Prime Minister is currently experiencing several quit threats from within her own party including the Scottish Tory leader Ruth Davidson and Scottish Secretary David Mundell. In addition, hard line Brexiteers such as former Brexit Secretary David Davis have called for ‘full-scale parliamentary rebellion’, urging cabinet ministers to ‘exert their collective authority’ to end the PM’s reign, once and for-all. As a result, markets awoke to a much weaker Pound this morning as it opened almost half a cent lower against the Dollar and 35 pips lower against the Euro.

Looking ahead, aside from the key EU summit on Wednesday – this week sees a raft of UK data including reports on the labour market, as well as CPI and retail sales. A strong wage growth figure is expected out tomorrow, while headline CPI is also expected to come in higher as retail sales have the potential to disappoint. Saying that, mixed UK data will likely have a reduced impact on Sterling as sentiment around Brexit continues to be the main driver.

?? USD - For the Dollar, we are continuing to see fiscal US outperformance dominate FX markets after three interest rate increases this year and forward guidance indicating that there may be another four by the end of 2019; this has kept the Dollar well bid. However, as part of these increased interest rates, last week saw a plunge in the US stock market after a long run of almost undisrupted gains. Combined with the strongest domestic labour markets in 50 years which is causing an upward pressure on wages, the increase in interest rates and therefore borrowing costs are likely to erode company profit margins further going forward.

Looking ahead this week, we will see a further indication of the strength of the US economy with Retail Sales out today and Industrial production out tomorrow. In addition, Wednesday sees the release of the Federal Reserve’s September meeting minutes - when rates were raised for the third time this year. In the medium term, November US midterms and the ongoing trade war with China remain the biggest threats to continued Dollar strength.

?? EUR - This weekend, the bad news continued to flow out of Germany after the Christian Social Union, the Bavarian allies of Angela Merkel’s CDU, experienced their worst election results in 68 years. This has increased pressure on Angela Merkel’s leadership with voters instead choosing to support the green and far-right parties instead of her allies. As a result, the CSU will now need to form a coalition in a state it is used to ruling alone; a result that is apparently the fault of Merkel’s Federal government with party members indicating that ‘it’s clear something has to change.’ An increase in political instability for Europe’s largest economy has the likely potential to cause further Euro weakness.

Looking ahead this week, the highlight for the European calendar will be the Italian budget submission out later today and the likely negative response from Brussels. At our last update, Italy indicated plans for a 1.7% of GDP structural deficit for 2019/20/21, which if repeated – won’t be well received by the EU Commission and presumably a back and forth war of words will follow.

 

Summary: 
GBP: Brexit celebrations put on ice as negotiations stall around the Irish border issue amid quit-threats from senior government members;
USD: Dollar remains well-bid on the back of strong US economy amid global equity slump;
EUR: Angela Merkel’s position increasingly unsecure after her CSU allies lose their overall majority as part of Bavarian elections.

 

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