Sterling has remained on the sidelines for the majority of October. With some economic figures coming in below estimates, investors have adjusted their expectations accordingly, encouraging them to unwind sterling long positions. The pound is likely to remain on the back foot this month and we doubt economic figures can provide enough surprise to lure investors back into sterling. However, the latest Bank of England monetary policy minutes revealed a less dovish tone from the central bank, and if this continues, could help sterling resist a buoyant euro.
The market has been taking every opportunity to support a stronger euro, and despite some weak economic data, the single currency doesn’t seem to have run out of steam just yet. Even though the ECB outlined the importance of the exchange rate to the recovery, members haven’t displayed much concern towards euro strength. As excess liquidity in the eurozone declines, attention turns to the policy tools the central bank will use in order to support European banks.
Dollar weakness has continued into the new month despite managing to pare back some losses against both sterling and the euro. The US government standoff gave investors an excuse to sell dollars after the Federal Reserve kept monetary Policy unchanged in September. We should see the dollar begin to get back on its feet this month, as clearer data allows investors to get a better picture of the likely timing of tapering.
Dollar weakness has continued into the new month despite managing to pare back some losses against both sterling and the euro. The US government standoff gave investors an excuse to sell dollars after the Federal Reserve kept monetary Policy unchanged in September. We should see the dollar begin to get back on its feet this month, as clearer data allows investors to get a better picture of the likely timing of tapering.
Not looking great for sterling in the month ahead
It seems like the period of sterling superiority has faded, and now it is time for sterling strength to take a back seat. The market now views previous sterling strength as excessive, and with last month producing softer economic data, investors have been encouraged to reduce sterling holdings. Nevertheless the outlook on the UK economy hasn’t changed. Optimism regarding the UK recovery remains and strategists have begun to raise their forecasts for GBP/EUR. We expect solid data figures to continue in November, however in order to witness some significant sterling momentum, economic data will have to provide some significant upside surprise.
Last month we saw a slight shift in the Bank of England’s stance, and although there were no policy adjustments the central bank highlighted that unemployment has improved marginally faster than forecasted. The monetary policy minutes from the last meeting noted that it was now possible that unemployment will be lower, and growth faster in the second half of the year, than predicted at the time of the August Inflation Report. This less dovish language may be what is needed to keep sterling competitive especially against the euro this month. If the central bank continues to display a more positive tone about the UK economy (especially unemployment), it could reignite speculation about when the BoE will consider raising rates. Next week the BoE’s monetary policy committee will meet and it is unlikely that we will see any change in policy. Eyes will then await the release of the monetary policy minutes to identify whether this rhetoric has continued into November.
GBP/EUR
Euro domination
There has been a big shift in momentum in the last month, and the demand we had seen for sterling has now moved to the euro. Euro strength has become a hot topic, and although the ECB have remained dovish, their lack of concern about euro momentum has given investors the green light to buy euros. In the press conference after the last ECB rate announcement, President Draghi highlighted the importance of the exchange rate to the eurozone recovery but didn’t signal any immediate concern about the single currency’s recent strength. It was only this week that ECB member Nowotny said he doesn’t see any tool the ECB could use against the strong euro, and it is something that we will just have to deal with. With comments like that it is no surprise investors are bullish on the euro, and this against bearish behaviour towards sterling set the tone last month. Investors have disregarded some more disappointing releases from the eurozone, and penalised sterling for some poor UK numbers. However, this week eurozone unemployment data was released and showed unemployment rose to 12.2% allowing sterling to rally through 1.17 and close at 1.18. Inflation is also becoming an increasing problem, and with CPI now at 0.7% y/y, the pressure is mounting for the ECB to take action, and possibly cut rates. This may be an indication that not everything can be ignored, and some euro weakness is in sight.
European banks are running out of excess capital and the ECB has said that there are a number of tools available in order to support banks, sparking talk of another round of LTROs. In an interview, governing council member Nowotny said that it is clear that there would be a liquidity provision but refrained from outlining what measures the ECB would use. As the month unfolds, there will be more focus on this, and if one is announced, it is likely to dampen recent euro strength and edge GBPEUR higher.
The ECB has scheduled a comprehensive assessment of 124 of the most significant Eurozone banks between November 2013 and October 2014. This includes a Supervisory risk assessment, asset quality review and stress test. It is possible that banks will begin to reduce the amount of foreign currency dominated assets held, to purchase euros in an effort to clean up their balance sheet. This could begin to influence the rate also.
GBP/USD
Is the storm over?
Neither currency in this pairing had it easy last month, however the problems just kept piling on for the dollar. After more than two weeks in partial shutdown, the US government managed to raise the debt ceiling in time to avoid default, but this was only raised till February 2014. Whilst this decision removed the immediate threat of default, it was by no means a solution, and this set the dollar up for weakness. The influence the shutdown had on the economy has also affected the Federal Reserve’s decision on whether to taper their asset purchases this year.
As we enter the new month the greenback is under a little less pressure than it was in October. This week the Federal Reserve kept interest rates and asset purchases on hold for another month, as expected. In the accompanying statement, the Fed seemed optimistic, but said more evidence is needed in order to pare back stimulus. The less dovish language provided the greenback with some momentum, edging the GBP/USD rate lower. Whether we can see this trend continue is dependent upon the performance of US figures. The shutdown has given the central bank more time to assess economic conditions, and as distorted data clears the way for more accurate releases, evidence should begin to build in favour of tapering.
The September employment report revealed 148k additional workers and a decline in the unemployment rate to 7.2%, the lowest level since November 2008. October’s payroll reading is expected to be show a modest increase, highlighting the slowing trend in payrolls. The market will pay particular attention to employment figures and any indication of an improving labour market will encourage more bullish behaviour, as well as increased speculation about the timing of tapering.
In the month ahead we feel the dollar will stabilise but will remain vulnerable to some weaker data releases. This may provide sterling with pockets of opportunity to push the GBPUSD rate higher but there is a fair possibility we could see this rate marginally trend downwards this month.
