GBP: Nice while it lasted? - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, explains that GBP has registered its biggest one day loss in over 3 weeks on the back of a combination of political and economic factors. 

Key Quotes

“Yesterday the UK Q1 GDP data were unexpectedly revised to show growth of +0.2% q/q from a first estimate of 0.3%.  The slowdown from +0.7 q/q in Q4 was mainly due to weakness in consumer facing industries such as retail and accommodation as household spending slowed.  This has followed a spike in UK inflation and a related erosion of real incomes.  The weaker trend in retail sales activity has been evident in official statistics since the December release.  Although the April data provided better than expected results, the Office of National Statistics attributed the better tone to weather, suggesting it is unlikely to be sustained.”

“Strengthening the view that consumption is facing severe headwinds in the UK was the rise in CPI inflation to 2.7% y/y in April and the drop in March average weekly earnings to just 2.1% 3m y/y.  Insofar as household savings ratios in the UK are close to record lows and household debt levels are already close to record highs, there would appear to be little room for consumers to offset the drop in their real earnings.”

“In view of the pressure on consumers, we see risk that BoE rates could remain on hold through the whole of 2018.  While ECB policy is set to remain hugely accommodative, the strengthening in the Eurozone economic backdrop has triggered speculation that its QE programme could be tapered.  This backdrop suggests the recent surge in demand for EURs could sustain.”

“On April 18 when PM May announced the surprise June 8 general election, GBP/USD surged.  Many commentators linked this move with an alteration in market perceptions regarding the chances of either a hard or soft Brexit.  We are not convinced by these arguments.  Currencies tends to react favourably to expectations of strong, liberal governments.  Last month opinion polls suggested that May could be on course for winning a landslide.  Today a new YouGov poll is suggesting that the PM’s lead has shrunk to just 5 ppts.  GBP has softened as a result.”

“We would also argue that GBP’s recovery on the news of an election was significantly amplified by the fact that speculative short positions had recently reached record levels.  In recent weeks there have been signs that this short-covering exercise has now run out of steam.  Although there is still a lot of bad news priced into the pound, news that the EU27 had unanimously agreed to an uncompromising mandate on Brexit talks suggests that Brexit related uncertainty is likely to weigh on the pound again in the coming months.”

“A softer performance for the USD will put a floor under the GBP/USD exchange rate.  While we are bearish on the pound, we see GBP/USD as potentially holding around the 1.28/1.29 area in the coming months and we favour expressing our negative GBP view in the EUR/GBP cross.  We are forecasting a move towards EUR/USD0.89 by the end of the year.”