Sterling sunk to its lowest level against the US dollar since the beginning of the COVID crisis in March 2020 and against the Euro since February 2021. The sharp move lower can be seen as a perfect storm. Concern surrounding the UK economy, political instability and speculation growing of a more aggressive pace from the US central bank compounded the Sterling’s woes.
Worries persist as monthly GDP shows back-to-back negative growth
The economy contracted by 0.3% in April after it shrank by 0.1% in March. This raised concerns of a recession. Currently, both households and businesses have been hit by rising prices, which are surging at their fastest rate for 40 years due to record-high fuel and energy costs. The following day saw unemployment ticked higher from a multi-decade low of 3.7% in March to 3.8% in April while ONS measures of wage and salary growth came in lower than economists expected.
The Bank of England (BoE) now finds itself in an awkward position ahead of Thursday’s interest rate decision. Inflation is expected to hit double figures later this year. If the BoE raises too quickly amidst a slowing economy, it could further restrict consumer spending impacting growth; raise too slowly and inflationary pressures continue.
Political uncertainty adds to the weakness in Sterling’s performance
In recent weeks, we saw PM Johnson win his no-confidence vote but weakened in the process. Two by-elections are scheduled for the 23rd of June with the Conservatives expected to lose their seats, following two separate scandals.
Brexit and the Northern Ireland tensions have once again reared their ugly head again. The UK government has set out to make changes to the Northern Ireland Protocol under Article 16, following 18-months of unproductive discussions with the European Commission and members of the EU. The EU has refused to budge on this matter. Political unrest in Northern Ireland where the self-governing executive has collapsed, whilst ‘unionist’ support for the ‘Belfast Agreement’ diminished due to the questions posed by the protocol about the province’s place within the United Kingdom.
The BoE meeting will be the main focus of the market
Thursday’s meeting will illuminate the central bank’s priorities. Will they focus on tackling inflation or restoring growth?
Presently, the UK’s interest rate is at 1.00%, and the probability of a hike is a 100% expected. The big question is whether this is a 25 or 50 basis point move – currently 51.2% and 48.8% respectively. The market is expecting to see UK interest rates at circa 2.75%-3.00% by the end of the year. A more aggressive hike on Thursday could provide Sterling with a lift.
Markets speculate over a 75-basis point hike
The US Dollar continued to rally on Tuesday ahead of the Fed’s interest rate decision on Wednesday. In response to Friday’s US CPI inflation report, a higher probability for the FOMC to hike rates by 75-basis points on Wednesday saw a broad sell-off in risk assets and an increase in safe-haven demand. Subsequently, US Treasury yields are at a multi-year high as expectations for a more aggressive increase in rates and an updated set of projections, in particular the dot plots, will provide financial markets with updated policy intentions for September and beyond. Fed Chair Jay Powell’s accompanying press conference may provide investors with an additional reason for price action if further signals of monetary tightening measures are issued. Overall, investors are preparing for a hawkish policy message from policymakers with the only uncertainty being just how hawkish the report will be in nature.
The Dollar Index broke above 105 on Tuesday, the highest level since December 2002. The rally saw the US Dollar advance to multi-month lows against the Euro while reaching the strongest levels against the Pound since March 2020. The Pound meanwhile remains under pressure even as market participants expect a rate hike from the Bank of England on Thursday.
It’s a quiet remainder of this week on the US economic calendar. Monthly US Retail Sales figures will attract attention ahead of the Fed announcement on Wednesday evening.
The single currency holds its ground following hawkish rhetoric
The Euro has been able to hold its ground against the US Dollar and make gains against the Sterling following better data and hawkish rhetoric. The German ZEW investor confidence index improved to -28.0 for June from -34.3 previously, but marginally below consensus forecasts. There was further hawkish rhetoric from ECB officials with council member Knot stating that it was a real possibility that rate hikes will continue in October and December. He added that if conditions remain as they are now, the bank will need to hike more than 25 basis points in September. He added that he would be comfortable with hiking rates of 1.50%.
Eurozone data is quiet for the remainder of the week, but the market will keep a close eye on rhetoric moving forward and also the increasing political tension between the UK and EU.
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