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FX Update: UK Prime Minister May's speech tonight key for the GBP

Written by Howard Willcox on January 17th, 2017.      0 comments

Market Overview:
This week culminates in the inauguration of the President Trump on Friday but with US markets closed on Monday for Martin Luther King Day, we have already seen volatility kick-in early for Sterling. The pound tumbled on a report that U.K. Prime Minister Theresa May will signal plans to quit the European Union’s single market to regain control of Britain’s borders and laws in an upcoming speech on Tuesday. Safe haven assets from gold to the yen rose while stocks fell across Asia. Sterling declined as much as 1.6 % against the USD after The Sunday Times said that May will prepare to withdraw from tariff-free trade with the region in return for the ability to curb immigration and strike commercial deals with other countries. The pound pared losses after the U.K. Treasury was said to plan to calm investors after her speech on Tuesday and the Times of London reported Donald Trump would offer a quick trade deal to Britain when he assumes power. The British currency has now fallen 19 % against the US dollar since the nation opted to leave the EU in June’s referendum. The most recent declines have been driven by concern May would pursue a so-called hard Brexit.


The Australian dollar was among the best performers last week, up against the US dollar to 0.7518 and settling around 0.7500. The AUD/USD pair trimmed most of its December losses on the back of strong recovery in metals' prices, as Chinese Trade Balance figures showed imports continued rising in the world's second largest economy by the end of 2016, reassuring ongoing demand for Australian producers. However, ratings agency Fitch has revised its outlook for the Australian banking sector to negative amid concerns about rising household debt and pressures on the banks' profits. The agency said its revised outlook reflected concerns about rising house prices, growing underemployment in parts of the economy and the impact on the banks from China's worse-than-expected slowdown. This week the focus will be on employment data set for release on Thursday. The market is looking for a gain in employment of 10.2k with the unemployment rate remaining steady at 5.7%.


New Zealand
Last week was a quiet one for economic releases from NZ, but this week certainly provides more interest for the market. We have this morning seen the latest NZIER Business Confidence survey and it showed business confidence remained high with a reading of 28, up from the prior 26. This would indicate continued solid momentum in the New Zealand economy and that helps provide a buffer against unexpected events both locally and abroad. The survey also showed an improvement in pricing power for businesses which will be of note for the central bank as it may well suggest a pickup in inflation over the coming year. Tonight there is another Global Dairy auction and expectations are for a modest pickup in prices, which should help underpin support for the New Zealand dollar. Thursday then sees the release of building consents data which should remain largely unchanged from November. Of more interest will be the regional data, and in particular that of Auckland where consents have flattened off at a level below what is needed to keep up with population growth.


United States
The main data this week from the United States will be Wednesday’s December CPI figure. Following the election of Trump to the presidency, reflation and upside risks to the Federal Reserve’s 2.0%yr medium-term target have become a key discussion point amongst market participants. However we believe risks to their target are limited, with little likelihood of inflation running materially above 2.0%yr. That being said, results at or very near target are expected. As often noted during 2016, core inflation pressures are robust, with the core CPI currently at 2.1%yr. As the last of the oil disinflation washes out, headline inflation (at 1.7%yr in Nov) will tend to 2.0%yr. Critical to the inflation outlook remains the services sector. Rents have been and will remain a key support, and higher wages are also likely to add to inflation pressures. As such, gains of 0.2% for core prices will remain our base expectation. In Dec, oil will add to the headline result. Given the lead up to Friday’s inauguration, political events will also continue to have the ability to provide market swings.


News around Europe continues to be Brexit centric however data last week showed that industrial production in the Eurozone grew strongly in November. This suggests that the pace of economic activity in the Eurozone likely firmed a little at the end of last year. Specifically, industrial production (IP) in Germany rose 0.4 %t in November relative to the previous month. Although the outturn was not quite as strong as expected, the increase in October, which was originally reported to be 0.3 %, was revised up to 0.5 %. Italian IP rose 0.7 % in November and IP in France jumped 2.2 % during the same month. Both outturns were significantly stronger than most analysts had expected. There has been a disconnect in recent months between strength in “soft” data and lacklustre growth in “hard” data. Perhaps the “hard” data are finally beginning to catch up to the “soft” data. We are still sceptical that Eurozone economies have significantly turned the corner given that there continues to be a split in fortunes between the north and south European economies, lack of a convincing consistent uptrend and the political overhang of upcoming election. There is an ECB meeting on Thursday but even given the better data and higher inflation forecasts no big changes are expected.


United Kingdom
Brexit continues to dominate all issues around the Pound and the UK economy. PM May’s speech on Tuesday is expected to show no wavering on the key elements of control over immigration and ‘freedom’ from the European Court of Justice. It is virtually impossible to see how the UK can remain in the EU Single market under those conditions and it seems likely PM May will concede as much, while also sticking to a timetable of triggering Article 50 by March. Although leaving the single market will be a substantial drag on economic growth in the coming years, the red lines matter more to the PM. The GBP took a knock yesterday but any significant move lower requires harder evidence of future economic weakness, we may see a short-covering bounce for GBP after May’s speech.


We have seen a mixed bag of data from Japan so far this week. Core Machinery Orders were weaker than expected, but this was offset by a better than forecast improvement in the Producer Prices Index. Bank of Japan Governor Kuroda was on the wires yesterday and he repeated his often used phrase that “Japan's economy continues to recover moderately as a trend”. He added that Japan’s consumer inflation is likely to be slightly negative or around zero for the time being and that the Bank of Japan will adjust monetary policy as needed. There is little else scheduled for release from Japan over the rest of this week.


This week should prove and interesting one for Canada and the Canadian dollar with a number of key releases scheduled. Early on Thursday morning we have the Bank of Canada meeting and Monetary Policy Report. The market isn’t expecting any change in interest rates at this stage as the Canadian economy appears to be stronger than the BoC had expected it to be at this point. Inflation however is still well below their target rate and so the central bank won’t be completely comfortable. Also to draw focus later in the week we have manufacturing sales, inflation data, and retail sales numbers.


Major Announcements last week:

• Chinese Trade balance 275b vs 345b expected
• US retail sales 0.6% vs 0.5% expected
• University of Michigan Consumer Sentiment 98.1 vs 98.6 expected
• UK inflation 1.4% vs 1.2% expected