Pound for pound, a lower GBP is not the worst thing for the UK
- Pound trade in disarray as Brexit fears dominate markets
- Lower GBP ultimately not an unqualified negative for UK economy
- Focus likely to shift to US, Fed as nonfarm release approaches
By Neil Staines
“Finance is a gun. Politics is knowing when to pull the trigger” — Mario Puzo
Statements emanating from the Conservative Party conference in Birmingham have seen activity and volatility pick up somewhat this week. The confirmation that the UK government plans to trigger article 50 of the Lisbon Treaty by the end of the first quarter of 2017 has undermined GBP in FX markets (despite the better-than-expected manufacturing and construction PMI data) where it continues to plumb new cycle lows as we speak.
However, despite the indication that the Brexit negotiations will give no special favours to British financial-services companies (a specific pledge of David Cameron), the decline in GBP continues to boost retail spending, housing activity, and domestic equity valuations as the FTSE 100 probes record highs set briefly in mid-2015.
Some commentators have questioned the rationality in this seemingly anti-City, tacitly GBP-negative strategy – a perception that is only underscored by reports that the PM’s team has dismissed business calls for an interim deal to help ease the transition. However, now that the "trigger date" has been given a deadline, a further modest decline in GBP that supports retail sales, housing, exports and equities – particularly against the current uncertain global outlook – is far from the worst outcome imaginable for the UK economy.
Chancellor Hammond stated yesterday that “we must expect some turbulence as we go through this negotiating process”. The GBP "pressure valve", so far at least, seems to have played a vital role in easing the early stages of the transition.
Whether this is intentional or not, it should certainly stabilise the backdrop.
“Everything we see is a perspective, not the truth” — Marcus Aurelius
If we take a step back and look at the UK's economic backdrop, however, there are a number of further positives. Yesterday, a barometer of the UK’s manufacturing activity (for September), surged further, confounding many forecasters expectations that some of the August bounce would be given back. Instead, it reached its highest level in two years.
Further improvements in the growth of new business and output in the investment goods sector may also be a sign that capital spending is recovering from its early year low point.
Indeed, as economic activity in the UK continues to outperform forecasts (particularly those prophesied before the reality of the Leave vote was known), expectations of additional monetary easing will likely be reduced. Furthermore, we have previously discussed our view of the importance of fiscal policy going forward... as the prospect of stimulative UK fiscal policy becomes more engrained, continued strength in retail sales, housing demand, and money supply growth will make the UK and GBP start to look very cheap in FX markets – particularly relative to the rest of the Eurozone and the EUR.
GBP may look vulnerable in the very near term, but we increasingly see value over the medium term. Watch this space.
“The future... exists only as a spectrum of possibilities.” — Stephen Hawking
Elsewhere, the Reserve Bank of Australia met for the first time under the stewardship of new governor Philip Lowe overnight. While rates were left unchanged as expected and the statement was broadly similar to the last, the slight changes (notably acknowledging strength in some housing markets) were, if anything, an incrementally less dovish development.
As the week progresses, the market's focus is likely to ebb back towards the US and the implications for monetary normalisation. Interestingly last night’s comments from New York Federal Reserve head William Dudley appeared to backtrack from his recent hawkish rhetoric.
Voting member Loretta Mester, however, maintained her stance at the hawkish end of the Fed spectrum. Over the coming weeks we expect that real US interest rates will continue the process of bottoming.
What this means for the USD, however, is just as dependent on the global risk backdrop and that, at the current juncture, is more complex in its evolution.
Data will also play a more important role in shaping financial markets this week. Further strength in US payrolls on Friday will aid the nascent Treasury curve steepening and should continue to buoy the USD. In the UK, after largely ignoring the substantial positive bounces in manufacturing and construction PMIs, the market will find it much harder to ignore an equivalent bounce in the UK’s dominant service sector PMI tomorrow.
The pound may be lower, but we are far from dis-May!
— Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group