Could a sterling rebound derail the FTSE100?
Earlier this month the Bank of England Chief Economist Andrew Haldane admitted that the as far as the UK economy was concerned in 2016 last year’s referendum vote may as well not have happened, given the lack of any economic impact over the course of the rest of the year.
Without too many exceptions economic bodies have ended up with egg on their faces with respect to their short term predictions, underestimating the reaction function of people who were able to look through some of the more ridiculous hyperbole from both sides.
As we head into 2017 the data continues to hold up fairly well, though there are signs that inflation continues to pick up and this is likely to act as a brake on consumer spending in the coming months.
With retail sales already at 10 year highs it is inevitable that we would have seen a consumer slowdown in 2017, even without Brexit.
Last week UK CPI hit a 29 month high of 1.6%, while more worryingly input prices surged nearly 16% in December, which suggests that inflation could hit the Bank of England’s 2% target by the middle of this year.
For now wages are still tracking above this level at 2.7%, and with a labour market that continues to look tight, the hope is that this shouldn’t create too much of an income squeeze as the rise in input prices trickles down into the broader economy.
Of course now that Prime Minister Theresa May has outlined her Brexit plan there is a risk the economic outlook could change now that it has become clear that the UK will be leaving the “single market” and customs union, and that’s before we even start to consider the effects the Supreme Court ruling, which is due on tomorrow might have on sentiment.
That last week’s Brexit announcement didn’t see further sterling weakness could well be a warning that we may well have seen a near term base in the pound, given last week’s failure to push below the $1.2000 level.
Last week’s rebound saw the pound put in a key reversal week, a pattern which under the right conditions has historically been a warning of a change in trend. This is a pattern where the price opens sharply lower but is unable to sustain these lows and closes sharply higher, and well above the open of the previous week.
If we have seen a near term base in the pound this could also have repercussions for the recent rise in the FTSE100 to record highs. Indeed the recent rebound in the pound has seen the FTSE100 post its first negative week since the beginning of November last year.
Furthermore we have also seen an equivalent bearish reversal take place on the weekly FTSE chart which raises the prospect that we could well see further declines on top of last week’s decline over the next few weeks.
The next key support sits at around the previous record highs at 7,120, with a break below this level potentially opening up a deeper down move towards 7,000.
What the catalyst for a move like this would be is hard to say, but rather than a UK catalyst we could see it come from elsewhere, maybe the US. There may be a clue in the US dollars reaction so far to last Friday’s inauguration speech by new US President Donald Trump, where we’ve seen a sharp selloff in the greenback.
Could a sharp bout of US dollar weakness be the catalyst for a sharper decline in the FTSE100, as this would help push the pound back up towards the highs seen in December last year at 1.2800.
It could be this, combined with optimism about the prospects for the UK economy as the government’s strategy towards Brexit becomes clearer, which might suggest that the floor for the pound is in place for now, and therefore could mean that in the short term we’ve probably seen the highs in the FTSE.
This week we get the first iteration of UK Q4 GDP which is expected to show that the UK economy grew at 0.5%, slightly down from Q3’s 0.6%. An important caveat here is that this will be a very narrow view of the economy accounting for only 40% of the available data, but it will nonetheless be expected to point to another decent quarter and the 16th consecutive quarter of positive GDP growth.
It will also potentially cement the UK’s position as the best performing G7 economy in 2016.
For further comment from Michael Hewson, please call 0203 003 8905 or 07824 660632
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