Sterling above 1.4000 versus weak Dollar

Sterling reactive to dollar drivers

The pound was in reactive mode yesterday first dropping following the U.S. inflation data then rising back above 1.4000 as the dollar lost impetus. As the recent correction in equity markets continues, the reasons for the dollar’s recent rally have evaporated despite investors still not yet being comfortable with returning to the market.

The inflation data in the U.S. was inconclusive. It was unchanged from December and clouded the outlook for future interest rate rises as the Fed moves to a more pragmatic and reactive phase.

The UK inflation data released on Tuesday is providing underlying support for the pound, but this could be short-lived as, yet again, the pound is also benefitting from a lull in Brexit negotiations as talks move into a “consultation phase”.

The Foreign Secretary, Boris Johnson, made a speech in which he raised doubts about the “conspicuous and irrefutable” benefits of being within the customs union and single market. This did nothing to allay the fears of business leaders as it set out Johnson’s personal view of Brexit not what they could expect to be Government policy as talks continue.

The pound reached a high of 1.4022 overnight (6.30GMT) versus a weakening dollar but any further strength will be dependent upon the short-term direction of the greenback.

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Dollar shrouded in confusion as recent rally ends

The dollar index fell back towards multi-year lows yesterday following the U.S. inflation report which was inconclusive at best. Over the past year traders have been selling the dollar despite the widening of the gap in interest rate differentials widening based upon the expectation that the ECB will be forced to withdraw accommodation sooner than the fourth quarter.

The dollar index reached a low of 88.43 in late January, but its rally has been short-lived based upon the “flight to safety” driven by the correction on equity markets. Sentiment has turned back into “negative territory” and the index is approaching those lows again, having reached 88.84 overnight. The dollar has lost close to 2% in a little less than a week as supports become eroded and as global growth becomes more established other G7 economies will start to tighten monetary policy.

Industrial production and capacity utilization data will be released today in the U.S. A fall in production from December’s strong 0.9% accelerate the fall in the dollar index to below the late January low. Capacity utilization is picking up and is expected to reach 78% a tiny increase from December’s 77.9%.

Euro on calm seas but political upheaval on the horizon

The Euro has been in reactive mode for most of 2018 as growth continues to improve, inflation remains benign and the ECB studiously avoids any comment that could be construed as supportive for the currency. Mario Draghi has managed to “kick the accommodation withdrawal can down the road” for now, relying on his mantra that growth is not yet uniform across the entire region.

The inflation data, while supportive for the currency, has not yet reached a level that requires intervention either verbal or physical, so the Euro continues to rally based on both hope and expectation.

There are storm clouds gathering however in the shape of the Italian election which will be held in a little over two weeks. Volatility is going to increase as polling day approaches. A victory for a coalition, in which Silvio Berlusconi’s Forza Italia party will be the senior party and will contain a group dedicated to forcing Brussels to change immigration and fiscal rules backed by a threat to leave the EU if its demands are not met, is likely, according to polls.

The single currency has, so far, shrugged off political concerns with traders preferring to concentrate on economic fundamentals but as the election approaches concerns are bound to surface.