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There’s been a big downside move in sterling today. As can be seen from the first chart the GBPUSD has slipped below the upward-sloping trend line that has been forming since March this year. Yet at the beginning of this month cable was trending higher and looked on course to retest resistance around 1.3400/1.3450. This represented a big comeback as far as the GBPUSD was concerned, particularly following the October 2016 “flash crash” which saw the pair slump below 1.1800 in illiquid Asian Pacific trade in the space of a few minutes. Much of the recent pull-back in sterling is down to a change in investor sentiment towards the US dollar. The greenback has steadied over the past fortnight or so following a near-relentless sell-off against the euro since the beginning of the year. This saw the Dollar Index slide from 103.80 at the beginning of the New Year to hit a low of 92.30 just a fortnight ago - a decline of 11%. But the dollar has perked up lately as investors reassess the likelihood of further monetary tightening from the US Federal Reserve for the rest of this year. Yesterday New York Federal Reserve President William Dudley said that it wasn’t unreasonable for the Fed to hike rates again this year and start to trim its balance sheet. This suggests that the Fed is less worried about tepid inflation than previously thought.  

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Somewhat ironically, it was an update on UK inflation which led to today’s sell-off. Headline CPI (which includes food and energy) was unchanged from June coming in at +2.6% annualised against an expectation of +2.7%. Core CPI was also unchanged from the prior month and came in at +2.4% on expectations of a 2.5% increase. Both numbers suggest that inflation may have peaked back in May when Headline CPI hit 2.9% - nearly 1% above the Bank of England’s 2% target. The news seems to have taken the pressure off the Bank’s MPC to raise rates. It makes it less likely that other MPC members will join Ian McCafferty and Michael Saunders who both voted for a 25 basis point rate hike earlier this month. The probability of a rate hike before the end of 2017 fell below 23% after the release, compared with just under 50% for US fed funds.

Meanwhile, sterling hit its lowest level against the euro since October 2016. While there’s an element of uncertainty about how the UK will fare in the ongoing Brexit negotiations, the overriding driver for the euro’s rally since mid-April has been a general expectation that the European Central Bank (ECB) will soon announce plans to reduce its €60 billion per month bond purchase programme. There could be more news on this later this month when ECB President Mario Draghi addresses delegates at the Jackson Hole Economic Symposium. 

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Posted by David Morrison

Category: PM Bulletin


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