Sterling momentum strengthened last month after strong employment data encouraged sterling buyers to resurface. The pound managed to get the upper hand on the euro, whilst the dollar struggled to drive the GBP/USD rate downwards, despite the Fed’s tapering decision. As we enter the New Year, the same factors will influence the pound’s strength and the debate about when the BoE could raise interest rates will continue. The market’s eye will remain fixed on the improvements in the labour market as well as price pressures.
There are still plenty of questions regarding the eurozone, and although the region is showing signs of progress, the issue of deflation and a buoyant euro remains. The ECB have maintained their dovish stance in the last few months and have reiterated their commitment to price stability, claiming the central bank have various tools to combat low inflation. We are yet to know what these tools are, and going in to January, the market will be paying close attention to any language from the ECB which may shed some light on the central bank’s ammunition.
As we approach the next US debt ceiling, some of the pressure on the government has faded amid the agreement in spending levels reached by Democratic and Republican negotiators. Although this agreement avoids a shutdown occurring this month it has not yet been passed through congress and does not increase the US debt limit, leaving the potential for budget crisis still open. Tapering has finally begun, with the Federal
Reserve trimming $10bn from asset purchases reducing the total to $75bn a month. The Fed has managed to convince the market that tapering is not tightening and updated their forward guidance claiming that interest rates will remain low even after the unemployment rate has reached 6.5%.
The year begins on a positive note
With UK economic data still impressing, this month the market is looking for signs to help gauge how sustainable the recovery is. The outlook for the nation is pretty much unchanged and although the last inflation reading showed inflation fell closer to the BoE’s 2% y/y target, there is still a possibility we could see a rate increase in 2015. We know from the latest inflation report, that slack in the economy needs to be absorbed and business investment needs to pick up. The market seems to have pushed these details to the side for the time being and focus remains on the labour market as well as price pressures. As a result, we doubt things will be much different from last month. Language used by the monetary policy committee will be monitored carefully. Last month we witnessed a sterling sell off after comments from BoE member Weale suggested the central bank will maintain loose monetary policy even after the 7% unemployment threshold has been reached. This triggered sterling weakness and if more dovish language is expressed by the BoE we doubt the market will hesitate when unwinding sterling long positions. It will be a difficult month ahead for sterling. With tapering talk limiting potential gains against the dollar and euro investors still preventing the pound from holding on to levels above 1.20, a lot more is needed to get sterling to make any meaningful rebound.
As we approach the next US debt ceiling, some of the pressure on the government has faded amid the agreement in spending levels reached by Democratic and Republican negotiators. Although this agreement avoids a shutdown occurring this month it has not yet been passed through congress and does not increase the US debt limit, leaving the potential for budget crisis still open. Tapering has finally begun, with the Federal
Reserve trimming $10bn from asset purchases reducing the total to $75bn a month. The Fed has managed to convince the market that tapering is not tightening and updated their forward guidance claiming that interest rates will remain low even after the unemployment rate has reached 6.5%.
The year begins on a positive note
With UK economic data still impressing, this month the market is looking for signs to help gauge how sustainable the recovery is. The outlook for the nation is pretty much unchanged and although the last inflation reading showed inflation fell closer to the BoE’s 2% y/y target, there is still a possibility we could see a rate increase in 2015. We know from the latest inflation report, that slack in the economy needs to be absorbed and business investment needs to pick up. The market seems to have pushed these details to the side for the time being and focus remains on the labour market as well as price pressures. As a result, we doubt things will be much different from last month. Language used by the monetary policy committee will be monitored carefully. Last month we witnessed a sterling sell off after comments from BoE member Weale suggested the central bank will maintain loose monetary policy even after the 7% unemployment threshold has been reached. This triggered sterling weakness and if more dovish language is expressed by the BoE we doubt the market will hesitate when unwinding sterling long positions. It will be a difficult month ahead for sterling. With tapering talk limiting potential gains against the dollar and euro investors still preventing the pound from holding on to levels above 1.20, a lot more is needed to get sterling to make any meaningful rebound.
GBP/EUR
Towards the end of December we saw euro strength re- emerge and combined with lower UK inflation force the rate from levels above 1.21 back towards 1.18. After the ECB’s last rate cut, eurozone inflation rose to 0.9% y/y, providing the euro with some short-term relief. The ECB’s lack of concern about the currency’s strength encouraged the market to continue to support the euro, and it is unlikely that we will see any change in the ECB’s attitude towards the exchange rate this month. Whilst they have made it clear that targeting the exchange rate is not an option, they have withheld details about what tools are available to combat low inflation. In a number of press conferences and speeches ECB President Draghi has said that the bank expects inflation to remain low for a prolonged period and if downside risks materialise, the bank is ready to take action. There have been whispers that negative deposit rates may be one of the many weapons the ECB has at their disposal, and this month we may get more of an idea about what the central bank has in store. The prospect of another round of cheap loans for European banks may also creep back into focus. The market believes another round of LTROs is on the table, however the central bank are yet to provide any clarity on the likelihood of this happening any time soon. Investors will be listening attentively to ECB members’ comments for clues on the next likely move from the ECB.
There are signs that sterling’s strength has become more sustainable and so we expect the pound to
recover.
GBP/USD
We begin the new year with $10bn less stimulus
Ben Bernanke’s term as Chairman of the Federal Reserve will come to an end this month, paving the way for Janet Yellen to take up the post. Despite Yellen being considered a dove, she supported the move to kick start tapering this month and this suggests she may be less dovish than previously thought. She obtained the Senate’s approval (56-26) to become the first female Chief in the Fed’s 100 year history in last night’s vote.
The issue regarding the US debt ceiling will resurface this month, however, with Republican and Democratic negotiators reaching a deal on spending levels, the risk of a government default has diminished. The deal which is small in size should prevent a shutdown this month if it is approved by Congress, but new borrowings will also have to be passed if a budget crisis is to be avoided.
GBP/EUR: 1.2130
GBP/USD: 1.6280
EUR/USD: 1.3420
