At the start of last week Sterling fell sharply making fresh 3 month lows against the euro (with growing calls of parity from some analysts) as the markets focused on renewed Brexit nervousness amid concerns that economic recovery in the UK would lag behind that of the eurozone. The OECD highlighting that the UK economy would be the hardest hit of the developed world didn’t help, but the extent of the fall in Sterling pushed the currency into oversold territory and by the end of the week it had rallied strongly against both the euro and the US Dollar.
This recovery could be short lived however as there will be much for the market to digest this week beginning with the Sunday Times article on the Bank of England warning banks of a possible shift to negative interest rates being first up (read our last blog on negative rates). Whilst this is not a new news, the pound has fallen each time it’s commented on, and I suspect it will keep sterling on the back foot ahead of Wednesdays mini budget from the Chancellor and a further update on Brexit talks which are beginning to gain as much market focus as the relative pace of UK’s recovery from the coronavirus lockdown.
The short time line to the end of the year is now putting real pressure on the Brexit negotiations and concerns are growing that any deal could be a hurried bad deal or no deal at all with both scenarios seen as initially negative for sterling. That said, much of this could be priced in for now with repeated hints from PM Johnson that he “open” to an Australia style exit and warnings from Chancellor Merkel that Europe should prepare for the possibility that no agreement could be reached barely wobbled sterling’s recovery and for now I expect the pound to continue its path of least resistance and track higher.
The mini budget is likely to see the Chancellor announce a range of fiscal measures to try and kick start the economy, but it’s not clear how he will do this and it comes after investors saw through the PM’s plan to bring forward £5bn of infrastructure spend into the current year to the extent the announcement had little impact last week. With the UK’s heavy reliance on the hard hit service sector, I expect some measures focused on the rise in unemployment, with any significant new spend likely to provide support for Sterling, at least in the short term. However the market is (finally?) focused on fundamentals for now, and the relative pace of the UK’s economic recovery and comparisons to other G7 economies and any and all data releases will be watched closely this week.
In summary there is much that could derail last weeks recovery with any budget led upside supported or dashed by expected updates from Brexit negotiators and EU finance ministers on the much anticipated EU recovery fund (Thursday and Friday) with plenty of room for the market to be disappointed.
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