A week could prove to be a long time for Sterling

With a little under a week to go until the result of the Conservative Party Leadership Contest will be revealed and the UK will know who its new Prime Minister will be, the financial markets are reacting strongly to the threat of a no-deal Brexit.

With Brussels’ position unchanged there is sure to be further uncertainty as the new PM gets to grips with the task at hand. With the result expected by July 23rd, Boris Johnson has strengthened his position as the favourite to win the election.

If (when) that happens, the likelihood of a no-deal Brexit will grow given Johnson’s pledge to leave by 31st October with or without a deal.

Inflation data which was released yesterday showed that CPI remains at 2% which is exactly the Government’s target. Producer prices, the price paid for raw materials by industry and manufacturing fell by a seasonally adjusted 1.3% in June. Given the weakness of Sterling, this is a surprise and indicates a slowing economy.

The pound managed to recover a little from its recent losses yesterday mostly due to a weaker dollar. It reached a low of 1.2382 early in the day but recovered to close at 1.2432. Versus the euro, it reached a low of 1.1048, closing at 1.1077. It now looks entirely likely that 1.1806, the lowest level the pound has traded at versus the dollar since the referendum will be challenged in the coming weeks.

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Uncertainty remains over FOMC intentions

The financial markets remain certain that the FOMC will cut short-term interest rates at its next meeting on 30/31 July. However, the economic data emanating from the U.S. recently doesn’t paint a picture of such certainty.

The employment report, released at the start of the month, saw the economy create close to a quarter of a million jobs in June. This is hardly a signal of a slowdown in growth while purchasing managers indexes show that there is no sign of a contraction in manufacturing, industrial production or services.

The consumer is also “doing its bit” to grow the economy, with year on year growth in June, reported yesterday, a healthy 3.4%.

While the rate cut this month now appears to be “carved in stone” the outlook for the FOMC’s future plans remain shrouded in mist. A lot will depend on the Q2 GDP data which will be released on July 26th. Expectations are for GDP to be 2% following Q1’s 3.2%. This obviously indicates a considerable slowdown QoQ, but the U.S. is not even close to being threatened by a recession.

President Trump will obviously pin the blame if that is needed, upon the Fed for hiking rates through last year but there has been a significant global influence.

China’s Q2 GDP grew at its slowest rate in 26 years. This has been “hailed” as an indication of how President Trump’s pressure on Chinese exports is working. There is, however, a knock-on effect of a slowdown in China which reduces imports and hurts economies in several emerging markets.

Yesterday, the dollar index experienced a correction, falling to a low of 97.16 and closing at 97.21.

Parity is nobody’s friend in Brussels

The single currency finds itself moving towards parity versus two of its G7 counterparts and that is causing some concern throughout the EU.

Brexit concerns are driving the pound towards parity versus the euro. The euro has risen from a low of 1.3154 in June 2016 to a high. of 1.0666 in August last year. Meanwhile, over the same period, it has fallen from a high of 1.2556 to a low of 1.1106 versus the dollar.

The continued fall versus the dollar is a telling indication of the weakness of the economy since there is a convergence of short-term interest rates about to take place.

The indications remain that the ECB is looking at ways to provide further accommodation to the Eurozone economy since providing cheap funding to banks has not been successful.

While there is no current issue with short-term liquidity in the banking sector, the strength (or otherwise) of their balance sheets remain a concern. Various schemes have been suggested to remove bad loans from bank’s balance sheets since failing that they need huge injections of capital to be able to lend. Even if that were to happen, willing borrowers will be something of a rarity until some improvement is seen in the economy.

Inflation remains weak, despite ECB President Mario Draghi continually promising that it would rise driven by higher wages. The latest data, released yesterday, shows that it is well below the ECB target of 2%. In June, CPI was at 1.3% having risen from 1.2% in May. This is a move in the right direction but there is still a long way to go.

Yesterday, the euro managed to rally a little versus a weaker dollar reaching a high of 1.1233 and closing at 1.1225.