Inflation, wage data buoy Sterling despite “hard Brexit speech”

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23 January 2017

Auteur
Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.

Sterling provided the big surprise last week. It rose sharply after the much awaited speech on Tuesday by Theresa May, in a clear example of a “buy the rumour, sell the fact” trade.

S
terling received additional support later in the week as a result of upside surprises in UK inflation and wage data, which validated our view that the next move in Bank of England rates is likely to be up rather than down. The US Dollar had a mixed week, pressured in opposite directions by Federal Reserve Chair Janet Yellen’s hawkish comments and Trump’s off the cuff statement that the Dollar was “too strong”.

The under-performer of the week was the Canadian Dollar, where the Bank of Canada sounded an extremely dovish note at its policy meeting, worried about the uncertainty and potential negative effect of Trump’s protectionism on the Canadian economy.

Focus now shifts to the UK Supreme Court decision on Tuesday morning on whether Parliament must be given a say in the Brexit process, and any details that emerge on the Trump administration’s economic policies.

Major currencies in detail

GBP

A series of leaks had markets primed for an extremely aggressive speech by May on the UK’s stance in Brexit negotiations. In the end the speech was slightly more conciliatory than markets had expected. This, combined with the rather large consensus position that has been built against the Pound, and its objectively cheap level, brought about a fierce short-covering rally in Sterling.

Inflation and wage data provided yet another positive economic surprise, adding to the sense that the short and medium term impact of the Brexit vote will be mostly driven by currency depreciation and its feed through to activity and prices. We note that core inflation is now at 1.6% (Figure 1), not far from Bank of England targets. Strong wage growth and continued pass through from currency depreciation will continue to pressure inflation upwards, and we expect market talk of future Bank of England hikes to pick up in the coming weeks.

Figure 1: UK Inflation Rate (2014 – 2016)

EUR

The Euro has generally stayed out of the headlines lately and has moved in a fairly tight range. Last week was no exception.

Draghi’s speech on Thursday was generally dovish. The ECB does not see signs that core inflation is improving and is likely to see through the inflation-driven spike in headline inflation. Further, Draghi introduced a critical new focus for the ECB. In addition to overall Eurozone inflation, the divergences in inflation levels between the different countries are being monitored by the central bank.

While the short term impact of these quite pessimistic statements was blunted by Trump’s complaints about the strength of the US Dollar, clearly the policy divergence across the Atlantic is going to remain at least into 2018.

USD

The inauguration of President Trump brought us much angry rhetoric but little additional clarity on the specific policies to be pushed in three critical areas: taxation, infrastructure spending, and protectionism.

This week, economic data and news from the US will be rather thin. We expect the focus to be entirely on whatever details markets get on specific measures in each of these three areas. Trump’s notorious twitter feed will continue to move markets, and currencies will be no exception.

DEEL