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Pound Sterling Leads Major Currency Advance on Dollar, Treads Water Against Euro

© Image © David Holt, Accessed: Flikr, Licensing Conditions: Creative Commons

- GBP leads major currency advance on USD in holiday trade.

- As FX markets trade with risk-on tone, stocks hit new highs.

- Amid reports of strong U.S. retail sales, China deal signing.

- And as EU Commission chief pitches UK transition extension.

- GBP to end 2019 back in the black after a rollercoaster ride. 

- Withdrawal bill set to clear parliamentary gauntlet in Jan.

- UK on course for Brexit, GBP turns to economy and BoE.

The Pound led a broad advance of major currencies against the U.S. Dollar in thin trade Friday after having found support on the charts earlier in the holiday-shortened week, although gains faded toward the end of the session.

Currencies were trading with in a risk-on manner ahead of the weekend after stocks hit new highs in the U.S. amid reports of a solid seasonal retail trade and just days after President Donald Trump said he and his Chinese counterpart will sign their phase one deal “when they get together.” Trade Representative Robert Lighthizer said earlier in December it would likely be signed next month, although the leaders are not scheduled to meet in January. 

Stock markets were higher but bond yields lower across the board in contradictory signals of the mood among investors, although with the biggest declines seen in U.S. yields it may not be a coincidence that every other major was able to advance on the greenback in the final session of the week.

Sterling led the charge after key chart support levels helped arrest losses from earlier in the week, albeit that gains faded around the London close.

“Equities are finishing the holiday-shortened week on a firm note, encouraged by strong holiday internet sales in the US,” says Marc Chandler, chief market strategist at Bannockburn Global Forex. “The dollar is trading lower against all the major currencies and most of the emerging markets."

Above: Pound-to-Dollar rate shown at hourly intervals. 

The Pound rose 0.70% to be quoted at 1.3084 against the Dollar Friday, the largest gain of all over the greenback, which helped Sterling to also rise against all of its major counterparts through much of the final session of the week. Although it had slipped below the 1.30 handle Monday and was close to 1.29 on Tuesday before rising through the Christmas holiday and in subsequent trading. 

Price action came in a session where relevant domestic news was thin on the ground although European Commission chief Ursula Von der Leyen was quoted widely in French and German press expressing doubt that any future relationship can be agreed with the UK before the end of 2020. The newly-minted head of the EU executive told Les Echos and Der Speigel in separate interviews that an extension of the Brexit transition period is likely to be necessary, and agreement would be required around mid-year.

Some traders may have been heartened by Von der Leyen's early pitch for an extension of the transition period, which comes before talks over the future trade relationship have even started, given how Sterling was rocked ahead of the holidays when Prime Minister Boris Johnson sought to rule out in law the possibility of any such extension being agreed.

Above: Pound-to-Euro rate shown at hourly intervals. 

Sterling was up Friday but amid broad-based weakness in the Dollar, while gains over the Euro were the smallest of all the Pound's advances, suggesting price action may have been driven more by international factors than Brexit headlines. Friday's Pound-to-Euro move followed a steep 'flash-crash' style Christmas day plunge that took place amid thin holiday trade.  

The Pound-to-Euro rate is near support on the charts that should hold in the absence of adverse economic or political developments. It slipped below 1.18 last week and was trading close to 1.17 on Friday but firm technical support is located just above 1.16, around which the British currency spent much its time trading during the six weeks heading into the December election. 

“EUR/GBP swiftly bounced off its current December low at .8239 and has now risen above the mid-November low at .8522 with the October low, November 22 high and 55 day moving average at .8571/.8600 thus being in the picture. This area we expect to cap,” says Axel Rudolph, a technical analyst at Commerzbank, referring to the inverse of the Pound-to-Euro rate. 

Rudolph says the Pound-to-Euro rate should find strong technical support around 1.1627 in the event of any fresh weakness up ahead.

Above: Pound-to-Euro rate, shown at 4-hour intervals, heads toward support around 1.16 ahead of Christmas break. 

“Net short GBP positions have dropped to their lowest level since May on hope that the new majority UK government will result in reduced political uncertainty. That said, PM Johnson is still using the threat of a no deal Brexit as a negotiating tactic in the forthcoming trade talks with the EU,” says Jane Foley, a strategist at Rabobank. "Brexit remains a driving factor for the pound."

Pre-Christmas price action came toward the tail end of a year that’s seen Sterling go from hero to zero and back again, with a strong start to 2019 having given way to punishing losses that endured into the Autumn months, only for Prime Minister Johnson’s Brexit agreement and subsequent general election win to drive a substantial rebound into year-end. 

Sterling has risen 9% against the Euro and 10.7% against the Dollar since early-to-mid October when Johnson first announced he’d agreed terms of the UK’s exit with the EU. And gains are even larger if measured from the lows struck in August when market fears of a ‘no deal’ Brexit under the newly-minted PM Johnson were at their fever pitch. That could mean a correction or retracement lowerwas probably always likely to follow.

"We suspect that the bulls have pared their positions amid the buy the rumor sell the fact activity since the election. Sterling returned to the $1.28-$1.30 band that persisted from mid-October through late November," Chandler says.

 

Above: Pound-to-Dollar rate shown at weekly intervals.

Boris Johnson succeeded in passing the Withdrawal Agreement Bill through its second reading in the House of Commons last Friday, paving the way for it to enter the ‘committee stage’ in the New Year and to complete the parliamentary process on January 08. The government has been reported to be aiming to have the withdrawal agreement ratified by January 09, which would mean the UK is on track to exit the EU on January 31. 

“The decisive election result has brightened the near-term outlook for the economy, but made it likely that the U.K. will be struggling to adjust to new trade terms in 2021. Our base case is that PM Johnson agrees a bare-bones trade deal with the E.U. just before the December 2020 deadline,” says Samuel Tombs, chief UK economist at Pantheon Macroeconomics

And with the UK then set to enter closed-door negotiations with the EU over the future trade relationship, Pound Sterling is likely to trade with one eye on Westminster and the other on the UK economy and Bank of England (BoE).

The BoE has been looking to raise interest rates in order to keep inflation in check but has stymied by uncertainty over the outcome of the Brexit process. Whether it gets an opportunity to lift rates, not to mention the Pound, will depend largely on the performance of the economy in the months ahead.

"PM Johnson's determination to use the threat of a no deal Brexit as a negotiating tactic will leave the pound open to bouts of selling pressure," says Jane Foley, head of FX strategy at Rabobank. "Political uncertainty is likely to act as a drag on growth and increase the risk of BoE rate cuts."

 

Above: Pound-to-Euro rate shown at weekly intervals.

Sterling is unprepared for an interest rate rise any time soon because for months now, it’s slowly but surely been pricing-in an increased prospect of a rate cut being delivered in 2020. 

Pricing in the overnight-index-swap market implies an April 2020 Bank Rate of 0.62% and 0.57% for August, both of which are below the current 0.75% but above the 0.50% that would prevail in the wake of a typical 25 basis point cut. 

That suggests lesser downside for the Pound than would otherwise have been the case in the event the BoE does cut rates next year, and much more substantial upside if it goes ahead with a rate hike. However, GDP growth and inflation prospects will be key to the BoE’s evolving stance on interest rates in the year ahead and that stance will in turn impact the Pound. 

Markets are looking for 2020 GDP growth of 1.1% and inflation of 1.9%, near to the BoE’s target, which implies a further slowdown from the 1.3% growth that’s been tipped for 2019. The UK economy is up 0.9% for the year and will miss the latter estimate in the absence of a 0.4% expansion in the final quarter, which is unlikely if the IHS Markit PMI surveys are anything to go by. Those have been suggesting for months now that a contraction beckons the economy this quarter.

“The UK looks set to leave the EU on 31st January 2020 and enter into a status-quo transition period until 31st December 2020. If the UK and EU can’t agree a trade agreement by then, something similar to a “no-deal” Brexit could follow. Meanwhile, Q3 GDP growth was revised up, from 0.3% to 0.4%. But this was driven by a boost from net trade, which we know has already started to unwind,” says Oliver Jones at Capital Economics. 

 

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