Good morning,
Sterling driven to 3 week high by inflation
Sterling ran above 1.25 yesterday as inflation numbers beat estimates handily and, once again, the only thing that people could talk about following the announcement was whether this will prompt the Bank of England to raise interest rates in the near future. Such was the move in expectations yesterday that a full rate hike is now priced in for August 2018; previously expectations were sat way out in the hinterland of 2019.
I think this is a very misguided belief that we’ll see the Bank of England hike interest rates any time soon. Given the increase in inflation and the trends that we are seeing in pay settlements we believe that as of this month real wage gains – pay increase minus the rate of inflation – are in negative territory. It would be very out of character for the Bank of England to hike interest rates at a time when the average consumer is getting poorer and the high street – by which the British economy almost lives and dies – is going to come under significant margin pressures.
Costs are the first shoe to drop and that then feeds in to wage settlements and unemployment; if British workers are not prepared to accept lower wages then unemployment will increase. This is the balancing act that the Bank of England must perform and until the picture of Brexit and the sterling depreciation’s impact on the wider real economy then we have to think that the Bank of England will sit on its hands.
What to watch now?
So moving forward we believe that it will be wage numbers and the PMI sentiment surveys from each sector that are the best barometers of these trends moving forward. Thursday’s retail sales announcement will allow us to see whether the High St is already feeling the ill winds.
In the meantime as long as traders believe that there is a chance of a surprise Bank of England rate hike then the pound will remain supported. It has to be said though as quickly as this support can appear it can disappear as well and BOE Deputy Governor Broadbent’s speech tomorrow morning is an opportunity for a centrist/neutral member of the Monetary Policy Committee to puncture this market psychology should he wish.
My frequent conversations with traders throughout the City confirm that the overriding thought is that sterling is an asset that traders are looking to ‘sell on rallies’; let it run higher and then sell on the basis that it is difficult to construct a ‘buy’ case for sterling given movements in bond yields, equity valuations, real wages and the underlying political risk.
Markets starting to dump Trump?
Part of the recent GBPUSD strength is also a notable level of USD weakness. EURUSD spent most of yesterday above 1.08 with USDJPY through the 112.00 level. If sterling is the most common thing that I’m asked about then whether the dollar rally can be sustained is the second and the moves of the past few days would hint that the rally is on very shaky foundations.
Testimonies against the Trump administration’s ties to the Russian government by the heads of the FBI and the NSA as well as the very uncertain passage of Trump’s repeal and replace of Obamacare health policies tomorrow night have heightened political and policy risk in the US. If Republicans rebuke Trump on healthcare then the market will be fearful of passage of budget and tax measures upon which a lot of this dollar strength has been based. Brexit gets the political headlines but Trump is still the biggest risk.
The Day Ahead
Today’s data calendar is quiet.
Have a great day