Evidence of the impact that the Brexit has had on the British Pound sentiment mounted this week. Sterling was unable to make gains, despite the better than forecast British Q2 GDP. Furthermore, when Greenback cratered following the Federal Reserve (Fed) policy update, Cable was unable to capitalize to the same degree. The political and economic uncertainty that the UK faces in the months and years to come is dominating GBP trading and the data calendar in the week ahead has markets nervous.
This week it was revealed that Q2’16 UK GDP bested expectations (+0.6% actual vs. +0.5 expected) as economic output accelerated into the historic EU membership referendum. However despite the strong result Sterling remains under pressure. This is because the data was pre-referendum and markets are primarily concerned post-referendum data. Unfortunately for the British Pound forward-looking data is not particularly encouraging as evidenced by last week’s soft PMI numbers. GBPEUR dropped multi-week lows as the anchor at 1.2000 that stabilised the pair in the early post-referendum period looks to be slipping. Sterling also finds itself lower this week against safe haven currencies like the Japanese Yen & Swiss Franc as markets shy away from British exposure.
Across the Atlantic, the American Dollar was beset by weakness following the Fed Monetary Policy update. As expected Yellen and her team left the benchmark lending rate unchanged. Rather price action was on the back of wording changes in the forward guidance which acknowledged that “near-term risks to the economic outlook have diminished”. Specifically the Fed cited tightening in the labour market and household spending as reasons for optimism. However, currency markets had largely priced these factors in and were left somewhat disappointed that the Fed guidance didn’t reflect stronger wording on when a rate hike might be expected.
As it stands capital markets have at 28% chance of a hike in September priced in and a 45% chance of a hike by the end of the year. Thanks to the Fed, EURUSD has found fresh legs and has bounced off of support around 1.10. However the prospect of rate hike is only partially priced-in. Should promising American economic performance persist, the pair could easily find itself lower as markets adjust their positions.
With Sterling traders primarily concerned with post-referendum data, all eyes are on next week’s July UK PMI numbers. No change is expected in the special Brexit Manufacturing and Services figures published the other week (49.1 and 47.4 respectively). The attention of the markets will however be on the first post-referendum Construction PMI number, forecasted at an alarming 42.3. An on target number would mark the lowest level since May 2009. This is particularly worrying as construction in the UK is nearly 50% financed by foreign investment. Such a dramatic contraction is an early, unnerving, sign of the state which the British economy now finds itself and future demand for GBP.
This steady release of post-referendum data from now onwards could result in a large amount of volatility in the markets next week as the public begin to see the immediate results of Brexit. Given that services currently constitutes 79% of the British economy, the services PMI is normally the most keenly watched- the notion of contraction has obvious consequences for broader economic measures like unemployment and GDP.
This Thursday we see the Bank of England (BoE) reconvene. Following earlier guidance that we will see some form of action from the BoE this summer, markets have priced in a 95% probability of a 0.25% rate cut. This BoE meeting also includes the release of the Inflation Report which contains the official economic outlook. As such Thursday could prove to be a particularly volatile in currency markets. It is clear that the BoE is likely to act this time around, however, Governor Mark Carney has previously stated that he fails to see positive outcomes of negative rates. Given that the benchmark lending rate in the UK is already quite near to zero, Carney is going to have to look elsewhere, like QE, to stimulate the economy.
Across the pond, next Friday will see the release of this month’s US Non-Farm Payrolls. Expectations are for a reading of 180K, a sharp fall from last month’s 287K, but create a nice average with May’s 11k is considered. The US non-farm payroll is usually one of the most significant piece of data in the monthly forex calendar, and thus broad currency volatility can be expected.
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