U.K. Growth Data Kills Chance of Hike

Sterling reacting to mixed signals

It is difficult to say whether a buyer of sterling is receiving “good value” right now due to the number of “outside influences” creating market indecision.

The pound reached a high of 1.3158 yesterday despite growth data which showed that the economy grew at a paltry 1% in the first half of the year. This is its highest level since September last year and is a reaction to weakness in the dollar.

A couple of weeks ago the market was uncertain over the future path of U.K. interest rates. That uncertainty remains but its immediacy has faded considerably.

Growth, inflation and Brexit have combined to take any chance of a rise in interest rates next week off the table.

Against the Euro, the pound is its lowest level this year. Brexit is having no effect on the single currency yet. The market is prepared to react to Brexit talks rather than consider what effect issues other than trade and free movement will have.

There is an expectation within the EU that the “bill” for Brexit that the U.K. will pay will “plug the hole” in the EU budget (that Brexit will cause) for at least five years after the U.K. departs. Depending on whether Brexit is hard or soft, the EU may be facing a major funding issue.

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Trade numbers illustrate U.K./EU co-dependency

Trade with the EU is a major part of the U.K. economy. In 2016, 44% of U.K. exports of goods and services went to EU countries while 53% of the UK’s total imports were from the EU.

Most EU members have a trade surplus with the U.K. and while the bloc insists on its “pound of flesh” for the U.K.’s departure, exporters in several countries will be concerned at losing a major buyer of their goods.

The relationship between the U.K. and EU has never been smooth since there has always been a “Eurosceptic” element to U.K. politics.

As EU chief negotiator, Michel Barnier has pointed out the clock is ticking. It is however ticking for both parties. Barnier has retained a “poker face” so far concentrating on areas where the U.K. has weakness.

The overall trade surplus that the EU runs with the U.K. is, potentially, more harmful to member states. In the big picture, it is a lot easier to find a new supplier than to find a new buyer. German exporters have already pointed out this fact to Angela Merkel and made it clear they expect her support.

FOMC retreats from further rate hike

The meeting of the rate setting committee of the U.S. Federal Reserve which concluded yesterday left rates on hold and provided advance guidance of a slowdown in the pace of hikes.

The opportunity remains to tighten monetary policy through the withdrawal of “extraordinary measures” and Fed Chair Janet Yellen changed her inference slightly saying that they will start to shrink their bond purchases “fairly soon”. The market took that to mean there will be an announcement at September’s meeting.

Inflation continues to confound the Fed, remaining low despite a growing economy. The two hikes so far this year following on in December 2016 were, proactive in anticipation of stronger growth. Any further hike this year (the market is pricing in a 50% chance), is likely to be more reactive as President Trump tries to pass his stimulus package through Congress.

The dollar index has fallen by close to 10% since January reaching its lowest level since June 2016.