Brexit and Rates vie for Top Billing

Sellers above 1.4000 hold sway

The prospect of gradually higher interest rates in the UK has provided support for the pound over recent weeks. The Bank of England has now turned more hawkish in the fight against inflation.

The Central Bank appears to have decided that irrespective of Brexit, inflation is going to be an issue and using the limited powers at their disposal, it needs to be dealt with if he economy is going to survive the disruption. The feeling is clearly that higher rates in the short term can provide an anchor on inflation while, given the already low starting point, won’t have a serious effect on growth which is in any event going to fall further if the Brexit negotiations continue in the manner they have started.

The recovery of the pound over the past three months has provided a certain amount of leeway to the MPC in their deliberations but the change in outlook since the November hike to the most recent meeting is impossible to explain. Very Little has changed, yet the comments about a dovish hike from November have now turned and even the most dovish members of the committee have become hawks.

The pounds’ recent rally looks exhaustive now with lower highs being made on every rally. Yesterday it fell back to a low of 1.3857 reaching close to the target following the recent 1.4280 trend high.

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Powell brings a calm head and little more

Jerome Powell gave his first congressional testimony yesterday and provided little new in the way of insight into the thinking of the Federal Reserve.

His words provided support to the greenback which continued its recent rally. The dollar index touched resistance at 90.50 but had insufficient impetus to drive higher.

Powell continued the recent mantra that rates would be raised gradually as the Fed move towards a normalization of both interest rates and monetary policy. He commented that the balance of risks favours a stronger outlook for the economy and doesn’t feel that the recent equity market volatility will have any lasting effect on growth. He believes that the U.S. is contributing to a period of global growth and is well placed to take advantage of the benefits that will bring.

He sounded a note of optimism about next week’s employment report commenting that historically low unemployment is going to lead to tightness in the labour market which will add to wage inflation. So far there is no sign of the more reactive Fed that commentators were expecting when Powell took over from Janet Yellen. The Fed’s pre-emptive actions that have characterized the recent rate hikes look likely to continue.

Euro falls versus broadly stronger dollar

The Euro seems to have finally broken strong support at 1.2280 as it continues its retracement of the rally which reached the medium term high of 1.2520. While the Eurozone economy continues to improve, the ECB and its President Mario Draghi, continue to obsess about the effect of a strong currency on weaker members of the region.

The ECB has no historical precedent to work with since this is a unique economic paradigm that has no basis in the past. Despite a currency that has risen by close to 20% the weaker economies have managed to export although the size of their tariff free and currency neutral trade within the region is significant.

Inflation remains benign within the region despite German calls for action to head off what they see as an overshoot later in the year. Sr. Draghi is determined that monetary policy will be used to create a level playing field for the benefit of all members of the Eurozone. Having now broken 1.2280 conclusively, the single currency should consolidate at lower levels unless this weekend’s General Election in Italy provides a surprise. The next support level is 1.2080 with buy orders lined up just ahead of that point.