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Markets look to UK wages for further Bank of England clues

In the absence of US markets for Martin Luther King Day yesterday, European markets underwent a fairly lacklustre and subdued session, finishing the day slightly weaker, in the wake of the IMF nudging down its 2020 GDP forecast for the global economy from 3.4% to 3.3%.

Not even a decision by France and the US to hold off on a potential tariffs war in the wake of France’s decision to implement a digital tax of 3% from July was enough to prompt any significant enthusiasm on the part of investors. The delay in implementing the tax certainly helps remove another potential flash point ahead of this year’s US Presidential election.

The lack of enthusiasm also appeared to lend itself to markets in Asia this morning after Moody’s ratings agency downgraded Hong Kong’s rating to Aa2 with a negative outlook saw stocks there slide, while weakness in Chinese markets has also sapped sentiment, over concerns that the spread of this new corona virus might prompt a repeat of the SARS outbreak of 2003, which spread across all of Asia.

In other news the Bank of Japan surprised no one by leaving monetary policy unchanged, with markets here in Europe set to open lower on the back of this morning’s slide in Asia markets

We’ve not been short of chatter in recent weeks that Bank of England officials appear to be leaning towards the prospect of another cut in interest rates over concerns about the weakness in the UK economy we’ve seen manifested in the past three months.

The slowdown is certainly a cause for concern; however, it also not surprising given events at Westminster and the uncertainty around the December general election. Who wouldn’t be cautious about embarking on new investment spending when there was an outside chance that a new Labour government, no matter how unlikely, won the political vote and then embarked on a raft of state sponsored nationalisations?

Against that backdrop and in the aftermath of last month’s vote it shouldn’t therefore have been too much of a surprise to see in a poll of CFO’s that business confidence jumped by the largest amount in 11 years.

The Bank of England needs to look at the UK economy through this sort of lens, after all they’ve spent the last ten years ignoring their inflation mandate, when prices have gone up sharply, so why the sudden rush to react to three months of subpar economic activity? 

Last week inflation fell to its lowest level in three years at 1.3%, increasing expectations that the Bank of England could act as soon as next week, particularly since recent commentary from MPC members has been leaning in the direction of a rate reduction.

On the plus side of the ledger, what has been encouraging is that wage growth has continued to be resilient with today’s wages numbers for the three months to November expected to come in at 3.4%, while unemployment is expected to remain steady at 3.8%, still close to 40-year lows.

Consumers do appear to have cut back as evidenced by a slowdown in retail sales in November and December, but that is by no means a bad thing given that consumer credit is quite high.

With wages growth still fairly robust and unemployment still low there doesn’t seem to be any risk in the Bank of England exercising a little patience and waiting until the March budget before making a decision on rates.

Besides with interest rates already close to record low levels it’s doubtful a 25bps rate cut will have the effect policymakers think it will, apart from juicing the housing market further.

With the Bank of England due to meet next week currency markets will be paying close attention to today’s panel at Davos where Mark Carney is due to speak, for any clues about next week’s decision.

The latest German ZEW expectations survey is also expected to show a modest improvement this month, with a rise to 15, from 10.7 in December.

EURUSD – the failure to consolidate a move above the 1.1170 last week has seen the euro slip back, with a test of 1.1050 which is trend line support from the lows last year at 1.0878. While above this level the risk remains for a move back towards 1.1200. A move below 1.1040 argues for a retest of the lows.

GBPUSD – the pound has found support at the 1.2960 level on at least three occasions in the past week or so. Only a move below 1.2950 opens up the prospect of a move towards the 1.2870 area. While that in itself is not evidence of a floor, a move above 1.3120 would in all likelihood prompt a sharp move back to the 31st December peaks above 1.3200.

EURGBP – last week’s failure at the 0.8600 level prompted a pullback to the 0.8470 area. We need a break either side of this range to signal the next move. A move above 0.8600 targets the 0.8790 area.

USDJPY – while above the 109.70 area the risk of further gains towards 110.70 remain on the table. Below 109.70 opens up support at 109.20 as well as last week’s lows at 107.65.

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