Sterling Lower Despite Optimism

Brussels silence on stage two seen as positive

Given the way in which Michel Barnier, the EU Chief Brexit Negotiator handled Brussels’ demands over stage one of the talks that will lead to the UK’s departure from the EU, I find the optimistic feeling that is surrounding the start of stage two, that has provided a platform for Sterling gains, to be worrying.

There is, for me, a distinct feeling of a “castle built on sand” since there are no firm grounds for optimism over the transition period and trade deal particularly since Barnier and his colleagues need to maintain a distinct gap between the benefit of being a member of the single market and being simply a user of that structure. It seems that financial services are going to be the initial stumbling block as David Davis the UK Brexit Minister has already called that sector “pivotal” to the success of the talks while the EU has said that the UK cannot “cherry pick” the parts of the agreement it desires.

Sterling continues to hold on to gains made during the Holiday period despite testing support at 1.3500 versus the dollar yesterday. Volatility on option contracts has fallen below that of both the Euro and Jpy as traders move away from the idea of a Hard Brexit and consequent issues that would bring.

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An Inconvenient Truth

Ignoring fact in favour of an idea of what the economy should look like at this stage of the cycle has become a recurring theme for Central Banks as the global economy emerges from the financial crisis. Inflation remains benign globally except for a very specific reason for imported inflation in the U.K.

Successive members of the FOMC have confirmed and/or agreed that the Fed will need to hike rates at least twice in 2018 and, in a few cases, three times to head off an economy that is forging ahead driven by a surfeit or cheap money.
With GDP more than 3%, inflation not yet at 2% and wage growth in the middle at 2.5% it is surprising that there is not so far any “voice of reason”, calling for a more reactive policy. It is the nature of Central Bankers to be alert to future developments around growth and inflation and they have teams of “number crunchers” creating models but a simple “look out of the window” policy would seem to suffice for now.

The dollar index continues to recover from its recent fall, reaching 92.64 yesterday before falling a little as the Jpy which makes up 13.6% moved higher on hopes for a tapering of their massive stimulus package.

Single currency struggling to hold above 1.2000

The optimism with which the Euro entered the New Year has dissipated somewhat as the currency has run into selling pressures above 1.2000 which have curbed traders’ enthusiasm a little. The base case is still for a stronger currency this year, but the ECB is painfully aware of not wanting “price exporters out of the market”, being held back by an unreasonably strong currency.

Mario Draghi, the ECB President, professes to not understand the desire to drive the currency higher despite the US Treasury, spurred on by the President, professing to want to weaken the dollar to improve the competitiveness of US goods overseas.

The euro remains below the 1.2000 level setting a low of 1.1915 yesterday and remaining weak overnight in Asian trading. Its next major support level is 1.1880.

A non-monetary policy meeting of the ECB has been held this week. This meeting is not followed by a press conference but given the view expressed by certain Council Members, they are likely to have discussed the withdrawal of extraordinary measures. Minutes from the last full meeting will be released tomorrow, any news of withdrawal of support will provide a boost. for the single currency.