Brexit and Politics Hit Pound

May fighting for control

The nature of U.K. politics is that it is never easy to believe what is said in public by Members of Parliament who are often following their own agenda in private. The messages of support for Prime Minister Theresa May coming from both Cabinet Members and backbenchers are therefore being treated with suspicion.

Since all Parliamentary business other than Brexit has been placed on the “back-burner” yet Brexit is not making any progress at all, it is reasonable to say that the Government is in disarray. The probable knock-on effect of this is that the fall in business investment will accelerate, leading to stagnant wage growth, a fall in the pound and higher inflation.

The performance of the pound last week illustrated perfectly that the market is losing faith in the ability of Theresa May to survive the hostility she is facing, let alone produce a Brexit that provides clarity and encouragement to British businesses. Sterling fell by 2.34% versus the dollar last week and by close to 2% versus a single currency that was facing its own political issues.

There is a sense of “another day another rallying call” as Mrs May prepares to brief Parliament with phrases like “progress won’t always be smooth” and “we can prove the doomsayers wrong”. Unfortunately, the reality is beginning to look a lot different.

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U.K. rate hike still considered probable

Over the past ten years, the “Central Bank Playbook” has been ripped up and consigned to the bonfire of history. Before that time, whilst it was never easy to say what Central Banks were planning with certainty their intentions could be modelled from the performance of several macroeconomic statistics.

So far this year, we have seen the U.S. Federal Reserve hiking rates in an economy that barely warranted such actions with inflation, in particular, below trend. To add to this the dollar has not generally reacted particularly positively to the Fed’s actions.

In the first week of next month, the Bank of England will convene its next meeting and the expectation of the market is that the Monetary Policy Committee will vote to raise rates. At the last meeting, the vote was 7-2 in favour of leaving rates on hold so this is quite a “volte face”. To say a rate hike will be a gamble is something of an understatement. A dramatically slowing economy needs to be balanced against inflation which will most probably break 3% this month and a pound which has started to fall again as the market digests the headwinds facing other G7 currencies.

U.S. employment data encourages rate hike expectations

The U.S. employment report once again proved its unreliability on Friday as the headline number showed that the economy shed 33k jobs in September although the August figure was revised up by close to 10%. This was well below market expectation but as is often the case with this data, the underlying numbers were surprisingly strong. The unemployment rate fell to 4.2%, well below the 5% level which used to be considered full employment and average hourly earnings rose by 0.5%.

This last piece of data reinforces the belief that the Fed will hike rates in December despite the assertion from their chairperson that they are no longer data-dependent when creating monetary policy. A pre-emptive hike in the short term is considered prudent by analysts to ensure that the pace and size of hikes doesn’t need to accelerate unnecessarily.

The dollar index rose to a high of 94.27 but failed to break strong resistance as profit taking set in. The Euro has managed to stabilize following a couple of political setbacks; Angela Merkel seems to have weathered the storm of her fall in popularity and the Catalan secession doesn’t seem to be as certain as was feared last week.

This week’s events of note

Sterling will be under pressure as the Conservative leadership issue could come to a head. The weekends papers will most likely provide a greater insight into the “frontrunners” of any leadership challenge.