Research Team at BBH, suggests that the economic data does not help very much to explain sterling's movement as the fact of the matter is that the UK has fared well in the three and half months since the referendum.
“The Bank of England took pre-emptive moves. These included deferring regulatory capital increase for banks, low interest rate loans, a formal cut in the base rate, and a new asset purchase plan that includes corporate bonds for the first time. Sterling has depreciated by nearly 16.5% against the dollar since the referendum and about 13.5% on a trade-weighted basis.
Even before the flash crash on October 7, sterling had been under pressure over the past several weeks. Most recently Prime Minister May gave official sanction to talk that Article 50 will be triggered at the end of Q1 17. Just as importantly, her comments suggesting an increase risk of a hard exit, whereby the UK would give up access to the single market in orders to gain more control over its immigration, weighed on the currency. Both Merkel and Hollande have also signaled their unwillingness to compromise on the basic principles.
In effect, investors have voted with their wallets that the UK out of the EU is less attractive, and have marked down the value of all the assets in the country. The rally in stocks (FTSE 250) have not offset the decline in sterling for foreign investors. UK bond yields have fallen since the referendum, but as global yields rise, UK yields rose fastest.
Last week, for example, the UK 10-year gilt yield increased 23 bp. The US 10-year yield rose almost 10 bp, while the Germany 10-year yield increased by a little more than 11 bp. The same is true at the shorter end of the coupon curve. The UK two-year yield increased by eight bp. EMU yields were 1-3 bp higher, and the US two-year yield was increased by nearly four bp.
The UK is at risk of a vicious cycle. For structural reasons, there is an efficient pass through of inflation from a weaker currency. There is also a relative quick pass-through of higher rates to UK households via the prevalence of adjustable rate mortgages. UK rates can rise even while the BOE is buying gilts. The depreciation of sterling will have an impact on the UK current account balance. It will be reduced, but do not be surprised if it comes from reduced volume imports as much as an increase in value exports.
Understanding sterling's pre-weekend dramatic price action requires sensitivity to both micro and macro forces. Micro factors can include things like uneven liquidity, role of computerized trading, changing market participation (few bank proprietary dealers), fragmentation of the foreign exchange market, and the role of derivatives (e.g. reverse knock-in or knock-out options, one-touch options). Macro factors may include central bank induced decline in volatility (higher bond and stock prices) and the occasional spikes.”
Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility.