After posting a modest decline on Monday, the rebound in the pound accelerated the FTSE 100's decline yesterday, as it posted its largest one day fall since 11 November last year. Despite this, the negative sentiment story wasn't just confined to the UK's blue-chip index.
US markets also finished the day sharply lower as uncertainty continued to build ahead of president-elect Donald Trump’s inauguration on Friday, as markets continued to feel the force of his willingness to defy convention and say and do things that previous incumbents of the Oval office wouldn’t do. Concerns about the new US administration's relationship with China have also rattled investors, after he criticised the strength of their currency.
His comments on the latest proposals around a border tax adjustment on importers as well as commenting on the strength of the US dollar have sown confusion and some uncertainty as to what sort of president he will be when he takes the oath of office on Friday.
Yesterday’s speech by UK prime minister Theresa May may not have pleased everybody, indeed it didn’t take too long before it was receiving criticism for being a “theft of democracy”, but it certainly had an unexpected effect on the currency markets, sending the pound up sharply, as it posted its biggest one day rise since 2008.
Having been told ad nauseam for months that the prospect of a so called hard Brexit/clean Brexit would send the pound even further down, this reaction was an unexpected outcome. However, given that immigration was always likely to be a red line, this was realistically the only option open to the prime minister, something that markets have had more than enough time to price in.
There is also the fact that finally we have more clarity and certainty than we did 24 hours ago, and as such the short-term outlook is much less cloudy. That doesn’t change the fact that the longer term outlook is still uncertain, but the difference is that was always going to be the case, whatever route the UK government decided to go down.
And that more than anything else is probably the most important element, and that amongst a number of other reasons is why the pound rallied as hard as it did yesterday, and could well strengthen further in the coming days and weeks.
The latest CPI inflation numbers weren’t particularly encouraging reading if you are a consumer, or for that matter the Bank of England’s monetary policy committee, rising to a 29-month high of 1.6%, however it does appear that the August actions of the MPC appear to having a significant upward effect on prices, the only worry being as to whether they’ve lit a fire, they might well struggle to bring under control.
As such this could well impact future decisions with respect to tapering the current stimulus program or even considering reversing the recent August rate cut.
This rise in inflationary pressure which is likely to increase further in the coming months will make it even more important that wage growth is able to keep pace. Last month, the rolling three month average for October weekly wages growth numbers showed an increase of 2.6%, and this level is expected to be maintained at 2.6% for the November numbers, while unemployment is expected to remain at 4.8%, an 11 year low.
The sharp drop in the US dollar also helped the pound's cause as a result of comments by Mr Trump when he stated that the currency was too strong, remarks that were re-emphasised by one of his advisors Anthony Scaramucci who warned of the effects of a strong US dollar.
To understand the reasons behind the sharpness of the US dollar sell-off, it is unheard of for a US president to comment directly on the strength or otherwise of the US currency, and it would appear that this propensity to do things his way is another instance of markets having to get used to Mr Trump’s different way of doing things.
The rise in inflation isn’t entirely a UK phenomenon either; we’ve seen prices rise across the globe with EU CPI inflation for December set to be confirmed at its highest levels in 32 months at 1.1%, ahead of tomorrow’s ECB rate meeting.
US CPI is also expected to show a sharp rise in inflationary pressures rising from 1.7% to 2.1%.
EUR/USD – the break above the 1.0670 area and move above the 1.0700 level has diminished some of the recent downside risk and could well trigger further gains towards the 1.0850 level in the medium term. For that to unfold we need to hold above trend line support from the lows this year at 1.0520.
GBP/USD – yesterday’s rally through the 1.2100 area was the catalyst for a sharp move higher, triggering stops all the way through the highs of last week, and above the 1.2400 area. If we move back above the 1.2440 area we could well see further gains towards the December highs at 1.2800.
EUR/GBP – the declines of the last two days could well be the catalyst for further declines towards the 0.8480 area. For this to unfold we would need to hold below the 0.8750 area, the break of which was the trigger for yesterday’s down move.
USD/JPY – the double top breakout identified earlier this week continues to unfold with the next target down at the 111.00 area. For now we have resistance around the 114.80 area which needs to hold in the short term.
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