Sterling recovers on hopes of ‘soft’ Brexit, UK inflation nears 2 year high

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19 October 2016

Written by
Matthew Ryan

Senior Market Analyst at Ebury. Providing expert currency analysis so small and mid-sized businesses can effectively navigate international markets.

The Pound soared in excess of one percent against the US Dollar on Tuesday, with suggestions that Parliament would be able to vote on the final terms of Britain’s Brexit agreement providing some much needed support for the UK currency.

A
lawyer representing the government over the right to trigger exit talks with the European Union claimed that MPs would ‘very likely’ be able to vote on the final exit agreement. We think that such a vote would lessen the risk of a ‘hard’ Brexit, where the UK’s access to the single market is severely restricted.

This led to a rare period of respite for Sterling, which as recently as last week hit its weakest position in trade-weighted terms on record. Sterling is likely to remain extremely volatile in the coming days as investors try to anticipate the next move in the Brexit drama.

Earlier, UK inflation data also surprised to the upside. Headline consumer prices rose 1% in September, well above forecasts and its fastest pace in almost two years (Figure 1). We think this could mark the beginning of an upward trend, with a significantly weaker Pound likely to push domestic prices even higher in the coming months.

Figure 1: UK Inflation Rate (2012 – 2016)

The US Dollar suffered from a mixed session yesterday, with investors taking advantage of the currency’s recent strength while evaluating the likelihood of an interest rate hike by the Federal Reserve before the end of the year. Inflation data out of the US yesterday provided further incentive for the Fed to hike sooner rather than later, with headline prices accelerating to a two year high.

This morning’s labour report in the UK will be the main data event in the calendar. We now await Thursday’s ECB meeting as the main event risk in the currency markets this week.

Major currencies in detail:

GBP

News out of the UK yesterday regarding Britain’s Brexit process sent the Pound 0.6% higher against the US Dollar, while rebounding off a near six year low versus the Euro.

While a majority of MPs are likely to vote in favour of triggering the exit clause, many are expected to demand both details of the economic impact of leaving the single market and immigration restrictions on EU citizens.

Meanwhile, yesterday’s inflation surprise was broad based, with clothes and fuel prices contributing to the bulk of the sharp increase in prices last month. Core inflation also rose to a six month high of 1.5%.

Wage growth and the unemployment rate this morning are expected to remain unchanged from August’s labour report.

EUR

The Euro sank 0.3% on Tuesday, erasing most of Monday’s gains and dipping back below 1.10 versus the US Dollar.

There were few significant announcements of note out of the Eurozone yesterday, with the single currency’s slump on Tuesday largely down to technical factors and a retracing in the Euro’s rally at the beginning of the week.

With no major economic data again today, all attention will be on Thursday’s European Central Bank meeting. We expect the central bank to keep its policy unchanged, while hinting that an extension of the programme could be on the way at the December meeting.

We also think Draghi will forcefully dismiss any talk of tapering asset purchases and expect a fairly bearish tone to weigh on the Euro, given the relatively poor economic news out of the Euro-area.

USD

A mixed session for the Greenback ended with the currency unchanged against its major peers.

The latest inflation figures out of the US yesterday were inconsistent with an economy adopting emergency settings in monetary policy. Headline inflation soared to a two year high of 1.5% in September, edging closer to the Fed’s 2% medium term target. Core price growth, which strips out the volatile food and energy components, remained little changed at 2.2%.

As slack in the US economy continues to diminish and the direct drag from the decline in oil prices abates, we think that inflation will continue to drive higher throughout the remainder of the year.

Housing data and a speech by Federal Reserve member John Williams will be the main focal points for the US Dollar today.

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