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Will Sterling Break 1.50?

Published 2015-11-24, 03:53 p/m
Updated 2023-07-09, 06:31 a/m

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

Tuesday's worst-performing currency was the British pound. It experienced broad-based losses on the back of dovish comments from the Bank of England. In the first half of the year, investors bought sterling aggressively on the belief that the Bank of England would raise interest rates shortly after the Federal Reserve. While the BoE is still poised to be the second major central bank to hike, the gap between the first move from the Fed and the BoE is widening quickly. U.K. data hasn’t been terrible (service and manufacturing activity accelerated in October) but policymakers are extremely concerned about low inflation. According to BoE Chief Economist Haldane, “balance of inflation risks is skewed materially to the downside.” BoE Governor Carney was less pessimistic – he said productivity may pick up faster than forecast but he was worried about the “significant” pressure on households and raised concerns about how rate increases could hit consumption. The big problem for the BoE is the strength of the currency. Since the beginning of the year, sterling appreciated between 8 to 10% versus the euro, Australian, Canadian and New Zealand dollars. Not only has the strong currency put downward pressure on prices in a low-inflation environment, but it also hurt exports. The U.K. conducts the majority of its trade activity with the European Union and the recent slide in EUR/GBP means trouble for the economy. Recent developments have been negative for the pound and at this stage the 1.50 level in GBP/USD is looking dangerously vulnerable.

The euro may not have been Tuesday’s biggest mover but it was certainly the market’s center of focus because for the second day in a row better-than-expected German data prevented EUR/USD from falling further. If there was one thing that could change the ECB’s mind about easing, it would be an improvement in the region’s largest economy. In contrast to the U.K., which is suffering from a strong currency, the Eurozone is benefiting from a weak euro. German manufacturing activity and business confidence improved in November. The rise in confidence is particularly impressive considering that it comes after the Volkswagen (DE:VOWG_p) scandal, refugee crisis and Paris attacks. It will be important to see whether this improvement can be sustained for another month as the ECB makes its decision on stimulus before seeing the next reports. Judging from the recent turn in data and ECB rhetoric, fresh stimulus will be introduced next week but the central bank’s actions may be less aggressive as it leave its options open to take additional steps in the months ahead if the economy worsens.

After rebounding on Monday, the U.S. dollar traded lower against all of the major currencies with the exception of the British pound. The latest round of U.S. economic reports was mixed. Q3 GDP growth was revised significantly higher from 1.5% to 2.1% but personal consumption was revised lower. House prices increased according to S&P CaseShiller but while the October trade balance narrowed, imports and exports declined. Consumer confidence also tumbled and manufacturing activity in the Richmond region contracted for the third straight month. There’s certainly more negative than positive surprises, which explains the dollar's decline. Still, these disappointments won’t stop the Fed from raising interest rates next month. The geopolitical tensions between Turkey and Russia also drove commodity prices higher and USD/JPY lower.

Tuesday's best-performing currency was the Australian dollar. The recent strength of A$ has been driven entirely by central-bank speak. Despite weaker data and lower commodity prices, policymakers remain optimistic about the prospects for Australia’s economy. On Tuesday morning, RBA Governor Stevens said Australian firms have stepped up hiring and the prospects for non-mining economy is improving. This comes after the Treasury lowered its GDP forecast for the year. Gold and copper prices rebounded slightly but remain weak overall. For the past 3 days, the AUD/USD rally stopped right around 0.7350. If this level is broken in a meaningful way, the next challenge for the currency pair will be the October high of 0.7382.

The more than 2% rise in oil prices drove the Canadian dollar higher against the U.S. dollar. As we have said all week, oil has and will continue to be the primary driver of Canadian dollar flows. Oil-inventory data is scheduled for release on Wednesday and as usual, the report will have a meaningful near-term impact on the currency. Many economists have been watching the 2 year U.S.Canadian yield spread, which is close to making new highs. A strong move to the upside for the spread and a slide in oil prices would be needed to drive USD/CAD to a fresh 11-year high above 1.3457.

The New Zealand dollar also performed well on Tuesday on the back of U.S. dollar weakness. The country’s trade balance report was scheduled for release Tuesday evening and while dairy prices increased in October as a whole, the slowdown in the business PMI index points to weaker trade activity.

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