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British Pound Recovery on Retail Sales Beat, May Undaunted by Brexit Vote Defeat, Euro Awaits Verdicts on U.S. Trade Tariffs

May will continue to push for changes

Prime Minister May will double-down on her current Brexit strategy after this week's defeat in parliament. File image © Number 10 Downing Street.

- Pound forecast to remain under pressure vs. Dollar, rangebound vs. Euro

- Pound finds relief in retail sales data

- May's Brexit strategy unshaken by defeat in parliament

- Euro awaits news on potential U.S. tariff recommendations on vehicle imports

The British Pound is in recovery mode ahead of the weekend, looking to take back some lost ground and ensure it does not secure the title of worst-performing major G10 currency of the week.

Aiding Sterling are some better-than-forecast retail sales data which showed a rebound in January from a steep slump in the final month of 2018, as consumers headed back to the High Street in the New Year, potentially setting the economy up for a recovery of GDP growth from a similar downturn back in December.

Retail sales grew by 1% in volume terms during January, more than reversing the -0.9% decline seen back in December, when economists had looked for growth of just 0.2%. This took the quarter-on-quarter growth rate up to 0.7%, from -0.2% previously. Annual growth was 4.2%.

"January 2019 has broadly returned to the same rate experienced in the summer with a growth rate of 4.2%; the highest since December 2016. This has coincided with a slowdown in the average store price (or often referred to as the “implied deflator”) to 0.4%," the Office for National Statistics says.

The release of the better-than-expected data sparked a recovery in the Pound: The Pound-to-Euro exchange rate turned around from 1.1341 at the time of the data release to begin a steady climb to current levels at 1.1376. The Pound-to-Dollar exchange rate has turned from 1.2792 at the time of release to trade higher at 1.2826.

Be under no illusion though, that the impact on Sterling will likely be short-lived with the main focus for currency traders likely to remain Brexit. "After a week of poor economic data, these figures are unlikely to have much impact on the Pound. Moreover, in today's currency market the strength of Sterling is largely being determined by markets' expectation of a deal or no deal,” says Lee McDarby, Corporate IP Managing Director at Moneycorp.

The Pound suffered losses through Thursday as markets geared up for the government's symbolic defeat in the House of Commons on Thursday evening after pro-Brexit Conservative MPs voted against a motion tabled by their government, arguing it would 'implicitly' remove the option of a 'no deal' Brexit.

The government suffered a loss by a margin of 308 to 258 after a swathe of Conservative party members abstained from voting with the government.

Members of the European Research Group - a bloc of Brexit-supporting MPs who advocate for a clean exit from the EU - withdrew their support for the government's motion on the basis  it implicitly ruled out a 'no deal' Brexit.

The worst-case outcome for Sterling over coming weeks would be a 'no deal' Brexit on March 29, and that parliament was unable to back a motion that would have arguably made such an outcome less likely has proven negative for the currency.

The Pound fell through the course of Thursday as various MPs telegraphed their intention to vote against the motion.

"Right now it seems as though we have to get very close to the 29 March deadline (remember there is an EU summit on 21-22 March) or a small majority in the Commons will force May to ask for an extension of Article 50 by the end of this month. Pressure is rising on all," says Kristoffer Kjær Lomholt, Senior Analyst at Danske Bank.

The Pound-to-Euro exchange rate now trades 0.50% lower on a week-on-week basis at 1.1347, Danske Bank still expect the 1.1630-1.1236 range to hold "before we get more clarification".

Indeed, there is a high probability the Pound enters a period of sideways trade as negotiations are pushed closer to the March deadline.

"The more important vote of course is late February though no one should bet against decisions not being made until the week commencing March 25," says Elsa Lignos, a foreign exchange strategist with RBC Capital.

However, the Pound is looking to be under more pressure against the U.S. Dollar which is one of the better-performing currencies this February. The Pound-to-Dollar exchange rate trades 0.89% lower on a week-on-week basis at 1.2826.

"GBP/USD has eroded the 50% retracement at 1.2830 and the 55 day moving average at 1.2812. This leaves the market under pressure and we have no option but to go with it at this stage," says Karen Jones, a technical analyst at Commerzbank in London.

Jones' attention "is on the downside and we would allow for losses to the 1.2739/61.8% retracement and potentially the 1.2669/62 15th January low and August low".

At present markets continue to hold a 'no deal' outcome as being a low probability outcome, with investment bank Goldman Sachs saying on Friday they believe there is a 50% probability that some form of a deal is ratified, saying there is a majority in the House of Commons to prevent a 'no deal' from taking place.

Analysts at Goldman Sachs say a 'no deal' would only likely happen by accident, and they weigh this at a 15% probability.

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May Unshaken, Dublin Under Pressure over 'No Deal' EU  Border Controls

Prime Minister Theresa May will continue to seek changes to her Brexit deal, a spokesman for her office said, after she suffered a symbolic defeat in parliament on her strategy.

"The government will continue to pursue this with the EU to ensure we leave on time on 29th March," the spokesman said.

The spokesman said May believed her Conservative lawmakers still wanted her to renegotiate the deal, but had voted against her on Thursday because they were concerned about the prospect of taking a 'no deal' off the table at this stage.

The UK is seeking legally-binding changes to the Irish backstop in order to ensure the backstop cannot be used as a mechanism that keeps the UK trapped inside the EU's reach for an indefinite period of time.

We believe Dublin holds a significant say on what concessions the EU gives to the UK on the Brexit issue, and we therefore find reports of growing pressure on Ireland from the EU interesting.

The EU has apparently put pressure on Ireland to budge, saying that in the event of a 'no deal' Brexit scenario Dublin would soon have to come up with a plan to ensure the integrity of the EU's single market or face checks on its own goods coming into the rest of the bloc.

"Ireland can get transition periods or some temporary opt-outs on the border in the worst-case scenario," a senior EU diplomat told Reuters. "Soon enough it will have to face up to the fact that either there is a border on the island or a border between Ireland and the rest of the EU."

It appears that the EU are saying that in the event of a 'no deal' Brexit - a 'no deal' that has come about because Ireland did not budge on the backstop - then the question of the EU border becomes Ireland's problem.

This messaging will not go down well in Dublin which typically enjoys unquestioned solidarity from the EU over Brexit. Leo Varadkar's recent statement that "I am the EU" comes to mind.

 

Euro Nerves on Potential U.S. Tariffs

The Euro is meanwhile an underperformer amidst fears that a potential tradewar might soon flare up between the U.S. and EU. 

Reports suggest that the Section 232 report on U.S. auto imports could be released as soon as today. The official deadline is February 17, but it is also possible that the report is not released to the public until a later date.

Leaked reports suggest the Bureau of Industry and Security will propose three options: a 25% tariff rate, a 10% tariff rate, or duties on electric vehicles only. The EU has also threatened retaliation with tariffs on electric vehicles including Tesla.

The Euro is propped up in part by the EU's sizeable trade balance that sees it export more than it imports, ensuring a stable demand for Euros.

Should this dynamic be threatened by tariffs, we could anticipate the Euro to weaken.

Hence we look for the issue to keep the Pound-to-Euro exchange rate supported near-term.

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