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Pound Sterling Being Driven by Stock Market Developments

- GBP's stellar run might be over
- Stock market sell-off weighs
- A testing Autumn for UK economy lies ahead
- Balance of risks are now lower

Stock markets Nasdaq and the Pound

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  • GBP/EUR spot: 1.1224 | GBP/USD spot: 1.3293
  • GBP/EUR bank rates: 1.1010 | GBP/USD bank rates: 1.3021
  • GBP/EUR specialist rates: 1.1123 | GBP/USD specialist rates: 1.3170
    Learn more about market beating exchange rates, here

The British Pound is recovering ground it lost to the Euro, Dollar and other currencies ahead of the weekend in tandem with a recovery in stock markets, confirming that for now the UK currency remains highly sensitive to broader investor sentiment.

Sterling is up a quarter of a percent against its two major peers on Friday, mirroring an improvement in equities that sees the FTSE 100 index trading 0.70% higher, Dow Jones futures are 0.80% higher and S&P 500 futures are 0.5% higher.

How Sterling ends the week could well depend on how investors behave on equity markets. "Stock market declines of this magnitude happen once in a while, especially after a massive run up as we witnessed in recent months. For a more structural downturn a catalyst is needed," says Jeroen Blokland, Portfolio Manager Multi Asset at Robeco.

The Pound fell on Thursday as a stock market decline centred on U.S. tech stocks saw the Nasdaq 100 index fall 5%; the Pound-to-Euro exchange rate fell 0.5% to 1.1208 while the Pound-to-Dollar exchange rate fell 0.55% to reach 1.3280.

"GBP/USD has been positively correlated with US stocks over recent months, so the decline in US shares saw GBP/USD also slide," says George Vessey, UK Currency Strategist at Western Union.

Technology stocks, such as Apple, Microsoft, Facebook and Tesla suffered sizeable declines amidst concerns they had become highly overvalued following a stellar run that has seen the sector eclipse the March lows set during the covid-19 market meltdown. Some analysts are saying a switch out of technology stocks into other relatively undervalued sectors might be occurring as a result of the now-questionable valuations in tech.

"There was a rout in markets yesterday led by the tech sector," says Jim Read, an analyst at Deutsche Bank. "Big tech was the main culprit behind the losses after having continuously powered forward since March... Many recent winners were particularly hard hit as profit-taking took over."

The linkage between the Pound and U.S. stock markets, which are in effect a proxy for broader investor sentiment, was most acutely highlighted in March when global markets collapsed in the face of the spreading covid-19 pandemic and the Pound fell to multi-year lows against both the Euro and Dollar.

"The move in the GBP is simply part of the broad move in risk assets and USD buying, nothing associated with Brexit," says Nick Bovell, Chief Investment Officer at Bovell Global Macro. "Therefore the market is still pricing in almost zero risk of a NoDealBrexit meanwhile bank analysts are pegging risks at about 30%".

Stock markets have recovered notably since March, as has Sterling, confirming the currency's 'high beta' (positive relationship to U.S. stocks).

Nasdaq 100

Above: The Nasdaq 100 index.

GBPEUR

Above: GBP/EUR exchange rate

The Pound tends to derive value from the inflow of foreign capital as the UK has a sizeable current account deficit, this ensures the Pound is left vulnerable when investors are nervous and capital is repatriated out of the UK.

There could however be other Sterling-specific factors behind the declines.

Some foreign exchange analysts are saying one driver behind Sterling's losses is the ongoing negative sentiment regarding EU-UK post-Brexit trade negotiations, however there were no new headlines concerning talks on Thursday.

Nevertheless, there was a sense that having climbed to 12-week highs against the Euro - which is typically seen as the benchmark for Brexit-related sentiment - the Pound was getting ahead of itself given the relentlessly negative headlines concerning Brexit.

The Pound is being tipped by some foreign exchange strategists to endure a difficult Autumn period as it is not just Brexit trade negotiations that will come to a head, but the economy's post-lockdown recovery could also hit the buffers with the ending of the Government's job support scheme widely held to be a significant hurdle for the jobs market and broader consumer sentiment.

(Learn more about how you can lock in current rates for use over coming months, thereby protecting your international payments budget).

The Pound had recovered over the July-August period against most major currencies, courtesy of a distinct lack of concrete headlines concerning the state of Brexit trade negotiations while unlocking the economy has seen the economy spring back and recover much of its earlier declines.

Yet, it is in October that two key developments occur: 1) EU leaders will meet in mid-October to try and agree on the final outstanding issues holding back a trade deal with the UK and 2) the government's job retention scheme comes to an end.

"Sterling could weaken if autumn comes and goes without the European Union and UK agreeing a trade deal, or strengthen if a deal comes to pass," says Robert Howard, a Reuters market analyst. "There is a 30% chance that the EU and UK fail to agree a trade deal before year-end, according to the latest Reuters poll of economists."

Investors will be asking themselves where do the balance of risks lie for Sterling at this juncture: is there more upside from recent multi-month peaks to be had, or given the building risks are they to the downside?

Price action over the course of the past 24 hours suggest the risk-reward of bidding Sterling higher has shifted somewhat.

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Ahead of the crunch EU summit that will determine whether the EU and UK can seal a deal, expect market nerves to be elevated and businesses to withhold investment and capital expenditure decisions.

"Overseas firms will remain reluctant to trade with U.K. suppliers, given the risk that supply chains might fail and prices will rise if the U.K. fails to sign a trade deal with the E.U. before December. Ultimately, we expect both sides to agree to extend trade talks—public opinion no longer is pressing the PM to stick to this year’s deadline - but the risk of no-deal probably will remain on the table until the last minute, impeding exports," says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.

October also brings with it the ending of the government's job retention scheme that saw the tax payer pay for employees to take time off work but remain on their employer's books in anticipation of the opening up of the economy.

"The unemployment rate will receive a further boost in the autumn as people who temporarily left the labour market during the pandemic return. By December, then, we expect employment to be 4.5% below its February peak and the unemployment rate to be hovering around 8.5%, matching its peak after the last recession," says Tombs.

The ONS reported on Thursday, August 20 that 12% of the workforce is still furloughed, which is down from the 20% who were furloughed in July.

67% of furloughed employees said they were receiving top-up payments from their employers as well as the 80% contribution from the Government.

September sees the Government reduce its contributions to 70% of wages and in October this falls further to 60.

The scheme closes at the end of the month suggesting the October-November period will provide a key moment in the economy's post-covid life with the scale of the jump in unemployment likely to impact Sterling.

Of course, if more employees move off furlough and back into their jobs the economy should end the year in decent enough shape and this could well aid Sterling. However, should the unemployment rate surge beyond the market's expectation then we would expect the Pound to come under pressure.


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