Rate hike disappointment may hit Pound and Euro

BoE rate decision to spark correction?

It is impossible to say just how much credence the market is placing on the possibility or otherwise of a rate hike by the Bank of England when its Monetary Policy Committee meets this morning. The Pound reached a new one year high against the dollar yesterday but resumed its slow-paced fall versus the Euro.

A “no-change” decision is unlikely to be sufficient on its own to push the pound lower but the tone of the Governor’s press conference may tip the balance. The pound has risen against the dollar solely in response to dollar weakness. There are headwinds facing the U.K. as the fourth quarter approaches that could see political turmoil, economic weakness and Brexit uncertainty.

An election, a rise above 3% in inflation bringing a further fall in real wages and a return to “no deal better than a bad deal” for Brexit could all see Sterling reverse most of its gain.

Politically, the situation is on hold. MP’s are on holiday and although there is clearly a “whispering campaign” no challenge to Theresa May’s leadership is likely before the Autumn. The Conservative Party Conference begins on October 1st and there is a chance that the Government may want a new leader in place to make that his or her coronation and mark (another) fresh start.

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Euro strength not derived from rate hike prospects

It is wrong to assume that the reason for the rise in the value of the Euro against its G7 counterparts is due to a near term expectation of a rate hike. Mario Draghi, the ECB President has been strident (well, as much as he can be given his mild-mannered personality) that no hike will take place in the medium term let alone the short term.

He remains concerned about the effect of tighter monetary policy on the weaker parts of the region and is aware of his responsibility towards all nineteen members equally. No central bank has yet started to reverse the emergency measures put in place to add liquidity and stimulate growth during the financial crisis. There is no precedent for what effect that will have on growth and/or liquidity so Draghi, Yellen and Carney will tread carefully.

The single currency is deriving strength almost by default. Interest rate differentials should have brought a stronger dollar but that is impossible right now. The U.K. and Eurozone are both affected by Brexit but the markets see it as tougher for the U.K. to come through it than the Eurozone although that remains to be seen. Even global risk parameters are at a reasonable level so the CHF and JPY are not attracting safe haven buyers.

The trend may continue for a while yet but as any trader knows there are always corrections within the major trend and their depth depends upon how strong the trend has been.

Dollar Correction looking for a catalyst

As already mentioned a currency trend is the one major market event that all traders can subscribe to and its duration is almost self-fulfilling.

The dollar has been in a downtrend since February although no one knew it was starting then. Momentum really increased radically in late June as supports were broken and the index went into virtual freefall.

The Trump Presidency can, to all intents and purposes, be discounted as a catalyst for a trend reversal since his credibility will take a long term to recover from the beating it has taken. Monetary policy may yet bring some relief as the Fed starts to shrink its balance sheet but that is a “fourth quarter decision”. The next FOMC meeting is on 19/20 September

Tomorrow sees the release of the employment report for July. A downward correction to the above trend 222k June headline will bring further dollar weakness although a small correction and an above trend July read may just stabilize the dollar and lead traders to feel that there may still be room for another hike this year. As in the U.K. the market will look for an increase in the workweek and weekly earnings as signs of inflation.