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UK Weekly Market Analysis
Sterling Led Higher as BoE Member Forbes Break Ranks

David Starkey February 9, 2017

– Euro slips as Greece bank into spotlight

– January CPI results posed to keep GBP & USD on alert

– Markets hunt for rate clues in Yellen testimony next week


Though trading has been especially choppy, sterling is expected to perform strongly this week. The British pound was lifted by comments from Bank of England member Kristin Forbes, who delivered a rather hawkish speech this week. Forbes noted that she was growing uncomfortable with the BoE’s stance, and said that “if the economy remains solid and the pick-up in the nominal data continues, this could soon suggest an increase in Bank Rate.”

Forbes’ comments highlight a growing division among rate setters and BoE Governor Mark Carney’s official guidance. On one side, there is a desire to offer support via accommodative policy growth that’s seen as fragile due to the potential for Brexit shocks. On the other side, there are concerns about the possible need to rein in run-away inflation with tighter policy. If inflation continues to drive higher in 2017, this dynamic could complicate the outlook for the UK and GBP.

The common currency came under pressure this week when Greece re-entered newspaper headlines. Concerns are growing that the indebted Mediterranean nation will not be able to meet the terms of its re-payment schedule, with the next tranche of funds due July 17th.  Greece is currently in the midst of negotiating for additional relief in the form of cheap loans from the European Central Bank in order to meet this requirement. However, willingness to restructure is limited on the part of lenders, specifically the International Monetary Fund, which has voiced concerns that the Greek government is becoming addicted to debt and steering toward an unsustainable cycle of spending.

Sentiment on the euro is already softening due to growing popularity of anti-EU populist parties in core euro zone nations which have elections in 2017. The addition of Greek debt concerns to the mix in 2017 darkens the outlook for EUR.

It’s a busy week coming up, with lots of potentially market moving events to be aware of. On the data front, January inflation results from both Britain and the United States will be big draws.

The BoE acknowledged last week at its Quarterly Inflation Report that price growth in the UK was running a bit hot. However at the same time, guidance stated that as long as data doesn’t overshoot current forecasts, the BoE was comfortable maintaining accommodative policy to support the economy though the uncertainty of Article 50 negotiations. Thus financial markets will scrutinize next week’s CPI reading for any indication that the BoE might have to revise its outlook higher. This in turn could up the pressure on Governor Carney and his team to tighten policy, which they have so far been reluctant to do.

On the subject of British economic data, next week also has retail sales on the docket. December’s retail sales result was the worst reading since May 2012, showing a contraction of 1.9% month-over-month. This economic “wobble” fueled speculation that early signs of fatigue in the British consumer are starting to show as the constant gloom and uncertainty of Brexit looms. Given lingering sentiment, a strong result next week will be needed to dispel those fears.

Looking beyond the UK, January CPI in the United States will be published on Wednesday. The last quarter of 2016 saw inflation in America turn a corner, so to speak, stabilizing after years of anemic performance. Greater optimism surrounding price growth expectations was a key part in the Federal Reserve’s decision to hike its benchmark interest rate in December and forecast a further possible three hikes in 2017. A strong result next Wednesday will be needed to reinforce current market expectations, which have a 20% chance of three rate hikes by the end of the year priced in.

Fed Chair Janet Yellen will be giving her semi-annual congressional testimony next week. The subject matter will focus on the Fed’s official outlook and how it plans to achieve its mandate of price and labour market stability in that context. As per normal, look for lots of focus on interest rates. The Fed took a slightly more neutral stance about guidance for tighter monetary policy in 2017 at its last update. This appeared to be a sort of subtle nod to uncertainty surrounding the new president, Donald Trump. This subject could be discussed next week during testimony and would draw the attention of currency markets.

With fiscal policymakers emboldened recently, testimony next week could prove somewhat more lively than normal. The traditional separation between fiscal and monetary policymakers that has been the backbone of the American economy in the modern era has already been compromised. Trump has repeatedly commented directly on monetary policy, both during his campaign and once in office, something which past presidents have tended not to do. With attention focused on this issue, the hearing could result in elevated volatility in both the U.S. dollar and broader currency markets.