Strong Data Lifts Sterling but Brexit weighs

UK Services Sector grew in May despite headwinds

The pound got an unexpected lift yesterday as data released on activity in the services sector of the economy grew from a reading of 52.8 in April to 54 in May. Market expectation was for a small increase given the poor April figure, but traders were taken aback, although the more pessimistic still see this as a one off since this is the area that will be most significantly affected in the short term by Brexit.

Activity in both the manufacturing and construction sectors had already surprised to the upside and this has led to a trimming of short Sterling positions although the market is under no illusion of the tough times to come.

Brexit remains the most significant driver of the currency which rose to a high of 1.3409 yesterday versus the dollar and 1.1463 versus the single currency. It settled back to close at 1.3390 and 1.1432 but has remained in positive territory overnight.

Traders remain braced for the announcement of the Government’s proposals for the future relationship with the EU. With the Parliamentary debate on the Brexit Bill taking place next week it is probable that the announcement will come before that. Whatever the proposals are, there is likely to be a period of turmoil around Sterling.

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ECB unlikely to act while Italian Government policies unclear

Yesterday, the new Italian Prime Minister provided an outline of his Government’s plans for the country. These provided a double-edged sword for Brussels. On the positive side, he said that the country had no intention of leaving the euro since, overall, it had been a positive influence over the country bringing financial discipline despite the burden the population had faced.

However, he went on to say it was time that the burden was lifted a little, announcing plans for tax cuts and increases in welfare that will increase Government debt.

Sr. Conte believes that that debt should be firmly held by Government and his plans intend to transfer borrowing from the people to the state. Italian Government bond yields rose on the back of the speech, but the Euro received a boost.

The single currency rose to 1.1733 versus the dollar but still faces severe headwinds as not just the significant increase in Italian Government borrowing, but a more general slowdown in economic activity across the entire Eurozone weigh on the currency.

There are rumours circulating that next week’s ECB policy meeting will announce the proposed date for the end of Quantitative Easing. I find that unlikely given the current slowdown in economic activity which means that an increase in the Asset Purchase Scheme is just as possible as a reduction.

Dollar under pressure despite an imminent rate hike

Recent data releases in the U.S. have all but confirmed that the FOMC will hike short term rates when they meet next week.

While the U.S. economy is performing adequately, inflation is still well controlled. Recent activity indexes have shown good growth, but it would be foolish to pin rate hike expectations on an entirely spurious employment report despite a marginal increase in wage growth.

Any change to interest rates in the U.S. is born of pressure from the administration for a normalization of rates sooner rather than later.

Given the speech made recently by Fed. Chairman Jerome Powell in which he reiterated the importance of independent Central Banks, free from Government intervention, there is still room for a surprise at next week’s meeting.

Mr. Powell is also committed to seeing hard evidence of the need for a hike although recent data may just about convince him,

The dollar index fell to a low of 93.78 and closed just ten pips from the low. Most of that fall could attributed to the relief rally in the Euro.

Today sees the release of trade data in the U.S. It is too early to see if there has been any significant change following the announcement of tariffs and restrictions, but this is a report which will gain in significance going forward.

The U.S. has been running a trade deficit of around $49 billion per month for quite a but this is due more to the export of U.S. manufacturing which has sucked in imports and excited President Trump.