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Sterling under pressure as Brexit tone changes

European and US markets had a rather subdued session yesterday with most investors content to sit on the side-lines ahead of the outcome of this week’s Federal Reserve rate decision where US policymakers are widely expected to ease monetary policy for the first time since 2008.

The main outlier was the FTSE100, which hit its highest levels in 11 months on a combination of M&A activity, and a sharp decline in the value of the pound. A weaker pound helps boost the profit potential for the vast number of multinational companies who derive the bulk of their earnings in US dollars.

The pound hasn’t exactly been flavour of the month in recent weeks anyway, but these losses have accelerated further since the weekend, after Prime Minister Boris Johnson said he had no intention of meeting EU leaders in person until they showed a willingness to change their position on the Irish backstop, and withdrawal agreement.

This hard line, so late in the day, appears to have prompted a sudden realisation that a no deal Brexit has suddenly become a much more likely event.

The surprise has been that it has taken the markets so long to wake up to the fact, given it remains the legal default, and the only way to prevent it at this late stage is to revoke article 50, or hope the EU grants an extension. The mood music around Brexit has certainly changed in the last week or so, along with the tone of the message, from the British government, which has become much more uncompromising, as compared to the more compliant tone of the May regime, which now seems a distant memory.

It is clear that the new UK government has taken the calculated decision to up the ante on the EU, at the expense of the exchange rate, in order to try and drive further concessions from a Europe, that is already struggling with significant economic weakness, and whose exports into the UK will now become much more expensive.

There appears to be a calculation being made that rather than risk a no deal, that both parties will come to a solution which prevents a shock dislocation which could ripple out across Europe.

Markets in Asia appear to have taken their cues from the subdued session in the US and Europe, while the Bank of Japan kicked off this week’s central banks activity by keeping rates unchanged.

No surprises here, however with the Fed due to conclude its two-day meeting tomorrow, Bank of Japan governor Kuroda will be keen to limit the upside in the Japanese yen from any decision by the US central bank to guide rate expectations significantly lower, when he holds his press conference later today.

The addition of an extra line to the Bank of Japan’s latest statement appears to show that they are concerned that the trade slowdown could well have ripple out effects in the Japanese economy. In it the bank pledged to take “ additional easing measures if there is a possibility that the momentum towards achieving the price stability target is lost”. Putting to one side that the momentum towards target over the last thirty years has been lacking, it nevertheless signals that Japanese policymakers are concerned that the current geopolitical tension is likely to see the target missed.

Today’s US core PCE data for June could well throw extra shade on tomorrows US rate decision, particularly if it follows on from Friday’s jump in US Q2 PCE numbers. Core PCE is the Fed’s preferred measure for inflation and currently sits at 1.6%. A move up to 1.7% is expected, however a bigger jump higher, to nearer 2%, while not deflecting the Fed from a 25bp cut tomorrow, could well influence the nature of the guidance for any second rate cut, and whether it happens this year. 

EURUSD – continues to hold the line above 1.1100 but the rallies remain weak. The bias remains for a move lower towards the 1.1000 area, while below 1.1280. We need to see a recovery back above 1.1280 to retarget the 1.1400 area.

GBPUSD – has continued to slide lower with the next key support area down near the 1.2100 area. Needs to hold push back above the 1.2580 area to stabilise and retest the 1.2700 area.

EURGBP – pushed through the highs last month at 0.9050 and through the highs this year, and could well retest the highs of 2016 and 2017 up around the 0.9300 area. This is likely to be a key level, which if broken could see further gains towards the 2009 peaks at 0.9805.

USDJPY – needs to push up through the 108.80 area to signal a retest of the 109.20/30 area. Bias remains to the downside and the 106.00 area, while below the 109.20 area.

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