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UK Weekly Market Analysis
Fed Minutes Appear to Green Light December Rate Hike

David Starkey November 23, 2017

• EURUSD tests two-month high
• Sterling contained by existing ranges following UK budget non-event
• Markets waiting for Brexit breakthrough as December deadline approaches

It was the minutes of the most recent Federal Reserve policy meeting which garnered the greatest interest from currencies this week. The minutes appeared to confirm that the Fed is still comfortable with a rate hike next month. However, the outlook for further rate hikes in the New Year was softened somewhat. Some members of the rate-setting committee voiced concerns about whether inflation could be sustained at target levels if the Fed continued to hike at its current pace.

The Fed is on track for a total of 0.75 percentage points’ worth of rate increases in 2017, if it hikes rates in December as expected, with a further total of 0.75 to one percentage point expected in 2018. Price action in the wake of the minutes saw greenback come under pressure due to the remarks about future rate hikes. Notably, this has helped EURUSD up to its highest levels since late September.

Activity in the British pound has been somewhat subdued this week. There haven’t been any notable data releases, and the UK Budget, which is the flagship channel for amending fiscal policy, failed to deliver any meaningful changes to taxation and spending. The budget itself seemed to be a not- so- subtle attempt to woo voters in demographics where the ruling Tory party would like to bolster its numbers. One interesting feature of the budget was the downgrade to growth assumptions that the Treasury used in its models. Regardless of what politicians might say in from to news cameras about what Brexit means for the UK, behind closed doors, they are concerned about the economic prospects after severing ties with the EU.

Sterling was virtually unmoved by the budget as it didn’t signal any change to the landscape that wasn’t already priced into currency markets. Recently GBP has settled into fairly narrow ranges against some of its major trading partners, including the euro and American dollar. In fact, for the better part of two months both pairs have traded in ranges of less than 3%. In the past, after a period of consolidation such as this, breakouts have been swift. Now that the Bank of England has hiked rates and doesn’t seem likely to do so again in the near future, it appears that sterling is in a holding pattern as it awaits fresh direction.

Speaking of direction for sterling, looking ahead to next week, the British currency will be dividing its attention between bank stress test results, the outlook for the manufacturing sector, and Brexit negotiations. Stress test results, published Tuesday, proactively highlight ways in which the integrity of the UK banking sector might be compromised given an economic shock. The Bank of England then analyses the results and can alter capital adequacy requirements to build up the resilience of the sector against future extreme economic conditions. A strong report card is a positive signal for the UK economy and, as it has in the past, could offer support to the British pound.  A weak showing could have the opposite effect as it signals that the banking sector might have to reign in activity.

Outside of the stress tests, the November UK Manufacturing PMI results on Friday could offer sterling direction.  Despite the initial post-Brexit boost to British manufacturers, thanks to the sell-off in GBP, the froth on top of the industry has settled. In fact, during 2017 British manufacturing has flat lined, leading to a general underperformance versus other developed nations. This underperformance contributes to the overall gray economic outlook facing the UK, and should data next week reinforce the malaise facing the UK manufacturing sector, GBP could feel the pinch.

The pound could be sensitive to perceived progress, or lack thereof, with respects to Brexit negotiations next week. As the Brussels imposed “substantial progress” deadline of mid-December quickly approaches, a sense of urgency appears to be building. The pressure is on UK negotiators to wrap up the matter of the Irish border and divorce bill. If this deadline is missed, then negotiations could go on hold until European Parliament reconvenes in March next year. If history is anything to go by, a multi-month setback could be received poorly.

Week to Date:
GBPUSD:   +0.68%
EURUSD:  +0.46%
GBPEUR:   +0.16%
Oil (Brent):  +0.65%
Gold:    -0.08%
FTSE:   +0.50%

Calendar:
Monday 27
No Data

Tuesday 28
GBP: Bank Stress Test Results
USD: Consumer Confidence

Wednesday 29
USD: GDP

Thursday 30
EUR: German Retail Sales
EUR: German CPI

Friday 01
GBP: Manufacturing PMI
USD: Manufacturing PMI

David Starkey

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