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July 2016

UK economy expected to contract

Published: Friday 01 July 2016

  • UK economy expected to contract 
  • EU credit rating downgraded
  • Carney predicts rate cuts and GBP falls

AUD

CAD

EUR

NZD

USD


Boris Johnson rounded of a successful Brexit campaign by announcing he would not attempt to become the Prime Minister on this occasion. The markets didn't react but traders and news reporters were all a bit stunned until it was clear that Michael Gove had announced his candidacy and stuck the knife into poor old Boris. Well at least Jamie Oliver doesn't have to leave the country now...so that's a blessing I know we are all grateful for.

 
The Governor of the Bank of England, Mark Carney finished the first half of the year by giving heavy hints that the BOE would cut interest rates in the months ahead; maybe as soon as 14th July or maybe on 4th August. A weaker Pound will cause some inflationary pressure but cutting the base rate will weaken it further and we saw some of that in Thursday afternoon trade. Interest rates have always been a very blunt instrument and a double edged sword. I know that is a bit of an oxymoron but you take my point. As mentioned above, Sterling slipped on the announcement and there is little in the way of scheduled data that will come to the aid of the Pound today. Traders seem to have sold enough Sterling for now and the Pound has stabilised this morning but the unexpected is to be expected at the moment.
 
The Euro would have strengthened against the Pound to a greater degree but for S&P downgrading the rating for EU debt from AA to AA+ and changing their outlook from Stable to Negative. The European Central Bank is hinting that they might need to loosen their rules on the types of debt they will purchase under their quantitative easing program. They haven't implemented that yet though.
 
In most currency pair, the Pound has fallen, mounted a small recovery as profits have been taken by speculators and then dropped back to the bottom of its range. In the GBPUSD rate, this is most pronounced and the Pound is now supported by a trendline which has underpinned this exchange rate since 1987. That would suggest it will continue to do so but, as we are repetitively told by the press, these are unprecedented times and that support could ebb away unless the UK government doesn't get on with the business of delivering a solid renegotiation of Britain's relationship with the EU. No pressure then.
 
For major data, we need to look West from whence the US manufacturing sector Purchasing Managers Index will be released. The markets are expecting a small uptick but the uncertainty of the Brexit vote may well have dimmed enthusiasm in all sectors, so don't be surprised if the USD weakens before the 4th July extended weekend.  Ironically, it is the day the American's celebrate independence from the UK. History repeating itself in a crazy twisted way.
 
And today marks the 100th anniversary of the commencement of the Battle of Albert, the first campaign of the Battle of the Somme. In this one day of fighting, Britain and our allies suffered 57,470 casualties of which 19,240 servicemen lost their lives. To visualise that number of people is difficult but if you watch the Wimbledon highlights today, with all the spectators, the players, umpires, staff, ball boys & girls and the press,  there are just about 40,000 people in Wimbledon on a busy day of the championships. It's sobering isn't it. 
 

Late Night visit

 
Donald Trump was sitting in his office late one night when Satan appeared before him. The Beelzebub said to Trump, "I have a proposition for you. You can become President, get a second term in office, have great support from congress and the senate and retire with a fantastic speaking tour contract and a whole heap of directorships in fortune 100 companies. The US public will adore you, your colleagues will stand in awe of you and you will make obscene amounts of money. All I want in exchange is your soul, your wife's soul, your children's souls, the souls of your parents and relatives and the souls of all your friends and colleagues."
Trump frowned for a moment before saying, "So, what's the catch?"

 

AUD

After the initial shock of the Brexit result had dropped the value of the Pound, it levelled off against most currencies. BOE Governor Mark Carney's heavy hints of UK interest rate cuts have damaged the Pound again although that is likely to unwind as traders start to evaluate the advantage that the UK derives from a weakened Pound. However, the Australian Dollar is still making ground against Sterling in spite of negative news from China; Australia's number one export client.   No one is predicting an interest rate cut from the RBA when they meet on the 5th July but there are growing expectations of a rate cut in August and that will weigh on the Australian Dollar. At 1.75%, the base rate is very attractive to overseas investors; especially with interest rates at virtually 0.0% elsewhere and an expected cut from the BOE in the coming months. Undoubtedly, the ramifications of the UK's exit from the EU will continue to cause volatility and that brings opportunity for both buyers and sellers. GBP buyers are eyeing the A$1.75 support level and AUD buyers are hoping for a bounce to A$1.84. These are both good technical targets. 


CAD

The Sterling – Canadian Dollar exchange rate is like most others in that it dived when the Leave vote was announced in the UK's Brexit referendum. Sterling was thumped by the news and it remains under pressure after the Governor of the Bank of England warned of interest rate cuts. Meanwhile, the Canadian Dollar benefitted from a levelling off in energy and commodity markets and these combined factors have driven the GBPCAD exchange rate from the C$1.93 high we saw ahead of the Brexit vote to the C$1.71 level I can see at the time of writing. From a technical standpoint, this pair ought to bounce from this low before resuming its downward path but every day seems to bring a new market-moving piece of news at the moment, so forecasts are great as long as no one of any importance says anything at all and we all know that won't be the case. 
 


 

EUR

With the wild movement we have seen in the Sterling – Euro exchange rate over the last couple of months, you have to take a very long term look at the charts to see what the pattern looks like. In fact this exchange rate has been in a slow upward trend since the worst of the financial crash in 2008. That took this rate from €1.01 in 2008 to €1.44 in 2015 and there have been a few dips in the meantime. The support for the Pound is arraigned along a trendline that now sits at €1.1930 and that is precisely where this rate is as I write. Now that the decision has been made to leave the EU, Britain has to get a new Prime Minister in place and start the arduous task of negotiating an exit. It is made easier by the fact that Europe needs the UK as an export destination but made harder by the EU's need to deter any other exiteers from making waves. There are undoubtedly troubled times ahead but the UK is still the 5th largest economy in the world and nothing will fundamentally change for 30 months or so. Meanwhile, you can expect a lot of volatility and great opportunities for buyers and sellers alike.


 

NZD

The very attractive interest rate yield that New Zealand can offer international investors is making the Kiwi Dollar a very attractive currency. So while the Pound suffers and the NZD benefits from inward yield seekers, the GBPNZD rate is bound to remain low. We are back down to levels not seen since 2013 and that is quite a modest fall in comparison with the GBPUSD rate. However, the New Zealand authorities will not the pain of a very strong NZD to continue for any longer than it has to and there are heavy hints that the reserve Bank of New Zealand may cut their base rate to deter inward investment and allow the NZ Dollar to weaken  – or at least to stop appreciating. The low we saw in 2013 was NZ$1.76 and there is every reason to expect that to happen again but this rate is heavily oversold at the moment so we can equally expect some sort of rebound. If that bounce does happen, it would be optimistic to target anything above NZ$1.93 at this stage.  That was the previous support level for the Pound and is now the resistance line.


USD

We hear a lot about how the Pound has fallen to the lowest level in 30 years but it is only the Sterling – US Dollar rate that is being cited in these reports. In fact this exchange rate is only just below the lows we saw in 2001 after the dotcom crash and 2008 after the credit crunch. That's not a glowing review but it does put this into more contexts. Sterling has found support on the trendline that joins all those previous lows and there are several technical support levels between $1.33 and $1.30.  The Pound is also showing as significantly oversold right now. So there is every chance for a technical bounce. However, any rebound will be small scale and short lived until progress has been made on EU trade negotiations. For now, we are into a new lower trading range for the GBPUSD rate between $1.30 and $1.36 until and unless something fundamental changes. That is happening almost daily at the moment, so we probably won't have to wait long for another reality.


 

Weekly Currency Insight by David Johnson

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