Policy, politics and the pound

By Mike McTavish | 6 October 2017

In recent weeks, there appears to have been a change in the BoE’s ‘reaction function’. The minutes from September’s MPC meeting highlighted that the majority of committee members believe that “some withdrawal of stimulus was likely appropriate over the coming months.”

Moreover, Governor Carney confirmed that he was among that majority, which currently is in favour of potentially tightening monetary policy in the near term. In addition, a speech from arch ‘dove’ Gertjan Vlieghe, in which he indicated “…the evolution of the data is increasingly suggesting that we are approaching the moment when the Bank Rate may need to rise” was quite rightly viewed by the markets as a further reinforcement of the shift in tone.

The change in rhetoric from the BoE has occurred against a largely unchanged outlook for the UK economy. Inflation has resumed its upwards trend and the labour market continues to tighten, both are most likely to have influenced policymakers’ thinking, with inflation in particular sorely testing the BoE’s tolerance for keeping monetary policy at these extremely loose levels to support growth.

We have also had the latest policy update from the US Federal Reserve who left interest rates unchanged and announced the start of the programme to unwind the asset holdings built up as a result of QE stimulus measures. Both of those developments had been widely expected beforehand.

The surprise news for markets was that a December interest rate hike remains on the cards. In the wake of the expressed concerns of several Fed rate setters that US inflation is still too low, many commentators had expected the Fed to hold off from raising interest rates again until next year. However they seem set to press ahead with a third rate increase this year.

From Europe, the very strong September PMI data suggest that monetary policy will also soon be on the turn in the Eurozone. The question beforehand was would these show any negative impact from the Euro’s recent appreciation?  Instead, both the manufacturing and services indices were up strongly from August.

Manufacturing in particular, which should be more sensitive to exchange rate moves, surged to a near seven year high. This increases the odds that the European Central Bank will announce a scaling back of its QE programme at the next meeting.

Yes, the markets are fixated with the developments around central banks and monetary policy but politics will remain a key driver (irritator) for the foreseeable future.

The German elections sent mixed messages to the market. While Chancellor Angela Merkel is set to lead a coalition, the better-than-expected results for the AfD highlight that even Germany has not been immune to the populist movement.

The highly anticipated speech from Theresa May in Florence was painfully subdued and the question remains as to how quickly negotiations will progress to the next stage, with the ‘divorce payment’, rights of EU citizens and Irish border all matters that remain unresolved.

With this hurricane of information and events the Pound has experienced many twists and turns during the past quarter. 

For GBP/USD we had a (1y) high of 1.3650 and a low 1.2784.  For GBP/EUR we had a high of 1.1430 and a low of 1.0744. 

These are sizeable moves in such a short period of time and from a trading point of view, these were very rapid moves with key technical levels passed with ease (worryingly, especially on the way down).

So what for the coming quarter?  It would be easy to say, ‘more of the same’ but I believe there will be even larger moves and volatility. Central Banks have upped the ante in respect to interest rate expectations meaning all policy meetings (BoE, ECB and Fed) to year end will have significant market attention, with significant volatility accompanying these events.

The Brexit train is only starting to gain traction so expect a lot more headlines towards year end, both positive and negative for GBP. 

There have been murmurings that he EU will make the divorce difficult, to send a clear message to any of the other unhappy ‘wives’ that breaking away from the union will be painful and costly. Of course this is mere speculation and we will have to wait and see what unravels as the months go by but one thing is guaranteed it will be a bumpy ride for the Pound.

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