Sterling Lower on Brexit Concerns

Brussels Plans Bring Irish Border row

The EU yesterday published its first draft of the proposed Brexit Treaty between the UK and Brussels and managed to bring to the fore all the concerns and doubts that had been simmering for some time.

There have been several issues that have been lingering following the completion of stage one of the talks, but it was always likely to be the question of the Irish border that provoked the most determined response. The EU proposals basically leave the UK divided with a border between Ireland and the mainland in the Irish Sea which is both politically and practically impossible to implement.

UK Prime Minister, Theresa May called the proposals “impossible”, commenting that it was a treaty that no UK Prime Minister could implement. Michel Barnier the EU Chief Negotiator laid the blame for any controversy firmly at Mrs May’s door saying that “the UK made the decision to leave the EU and the need to suffer the consequences of such a momentous decision.

The pound fell to lows not seen since early January as the economic effect of a hard Brexit replaced rate optimism as its prime driver. It fell to a low of 1.3756 and the weakness has continued overnight.

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Eurozone inflation data leads Euro lower

Any short-term thoughts of a tightening of monetary policy in the Eurozone were summarily dashed yesterday as inflation data was released which showed that price increases in the region are benign at best.

ECB President Mario Draghi has been consistent in his demands that interest rates should stay low until inflation is moving closer to the ECB target of 2% and that additional stimulus should continue to benefit the weaker economies of the region.

Eurozone inflation in January was 1.2%, down from 1.3% in December. The single currency fell to a low of 1.2187, continuing its recent correction although it is starting to attract buyers at this new, lower level.

Versus Sterling, the Euro had its largest one day rise this year reaching 1.1279 although the pound has steadied a little overnight.

The rise in the value of the Euro which now appears to have topped out close to its medium-term target of 1.2520 will have had a dampening effect on inflation and the subsequent correction that has been taking place over the past 2/3 weeks will add marginally to inflation. It is core price increases that have become static. Employment and wage inflation have also been static in recent months and until they start to rise, little change in overall price increases can be expected.

Powell optimism drives dollar higher

Just as the EU and UK were suffering from news which was negative for their currencies, new Fed. Chair Jay Powell was delivering an upbeat view on the U.S. economy which pushed the dollar index back above stubborn resistance.

The optimism engendered by Powell’s speech led traders to move their thoughts from three to four hikes by the FOMC this year. The first hike, in May, is now 100% priced in and as the economy moves forward, the move towards the normalization of interest rates and monetary policy gathers pace.

Mr Powell’s words did nothing to alleviate the concerns that are building over the twin U.S. deficits that will continue to grow even as the economy expands. Trade and budget deficits are set to hit record levels, but traders are content to live in the “now” and give the benefit of the doubt to the Fed.

Powell’s words sent a shockwave through global equity markets which have been rising driven by the availability of “cheap” money. The dollar also fell versus the Japanese Yen which retains its safe haven status as risk appetite falls. The dollar’s rally could be short-lived however as the market tended to “buy the rumour and sell the fact” of higher rates throughout 2017.