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Pound rises strongly on Brexit deal optimism

Published: Wednesday 12 September 2018

  • ​​Is strong economic growth benefitting households enough?
  • New Australian PM faces tough job
  • …And so does Theresa May over Brexit
Even a solid 3.4% growth in Australia’s economy could not stop GBP rising strongly against AUD over the last month, following optimism that the UK can still reach a deal on Brexit. In fact, the Pound soared from around 1.75 in typical mid-market rates at the end of August to around 1.83, two weeks later. It is now edging closer to the two-year high of 1.845. The monthly high was 1.833, while the low was 1.740. Quite a difference! The question is whether the strong growth in the economy is benefiting Australian households enough, particularly as they struggle with high debt levels. It’s enough to turn the average Aussie to drink. That said, it seems that the day of the hardened lager-swilling Australian may be over. Alcohol consumption has dropped to its lowest level since the 1960s, with a 2.4% fall in beer consumption on average for each of the last 10 years.
Is strong economic growth benefitting households enough?

National real Gross Domestic Product (GDP) rose by 0.9 of a percentage point in the June quarter with year-on-year growth at 3.4%, the fastest since September 2012, according to data from the Australian Bureau of Statistics.

But the Reserve Bank of Australia (RBA) is not getting excited. In fact, the statement from governor Philip Lowe, announcing that the cash rate would be unchanged for the 25th month running at a record low of 1.50%, was very similar to July’s.

It highlights slowing growth in China, uncertainty over United States trade policy and increasing inflation where there are tight job sectors.

The bank still expects positive business conditions with the Australian Dollar remaining within the range that it has been in over the past two years on a trade-weighted basis.

Unemployment, at a six-year low of 5.3%, is set to fall to around 5%. Inflation, currently around 2%, is expected to rise a little over the next two years.

But Michele Bullock, Reserve Bank Assistant Governor, warned separately about the high level of national debt, which is currently at 190%. The figure is fuelled by high levels of home ownership and the amount of mortgage debt.

The bank is particularly concerned how a trade war between the United States and China will affect the global economic recovery.

Ms Bullock says, “Household debt in Australia has risen substantially relative to income over the past few decades and is now at a high level relative to international peers. This raises potential vulnerabilities in both bank and household balance sheets. While the risks are high, there are a number of factors that suggest widespread financial stress among households is not imminent. It is nevertheless an area that we continue to monitor closely.”

There is also some debate that Australia’s strong economic growth needs to be seen to be benefiting households more.

New Australian PM faces tough job
New Prime Minister Scott Morrison faces a tough job to fight off an early election.

He took over in August, after a backbench revolt forced out previous Liberal PM Malcolm Turnbull.
But Mr Morrison now has no majority in the Liberal-National coalition in parliament and faces a real battle to stave off a no-confidence vote and an early general election.

In fact, a poll in the Australian newspaper showed the coalition would lose up to 30 seats if an election was held now, with Labor ahead by 56% to 44% on a two-party-preferred basis.

Any further political uncertainty is likely to weaken the Australian Dollar against major pairings.
Australian Money close up - Halo Financial

…And so does Theresa May over Brexit
Theresa May is another PM with a tough job. She now has less than 200 days to reach agreement with the European Union over the terms of Britain’s exit from the European Union on 29 March 2019.

On top of that, she is facing an uphill battle to get through her Brexit plan ironed out at Chequers, with a rumoured 80 MPs threatening to vote against it, according to former junior Brexit minister, Steve Baker.

Among opponents is former foreign secretary and ‘big beast’ Boris Johnson, who controversially condemned the plans as “a suicide vest” wrapped around the British constitution.

But chief negotiator for the EU, Michel Barnier, offered fresh hope by suggesting a deal could be reached by early November 2018, if negotiators were realistic.

Both sides are hoping to finalise a potential £39 billion ‘divorce’ agreement and agree terms of future economic co-operation.

However, Mrs May first has to face the autumn Conservative Party conference in Birmingham in October, two weeks before a European Council summit on 18 October, at which a final Brexit deal could be agreed.

If that does not happen,  a one-off summit of European Union leaders could be arranged in the middle of November to take a final decision.

Nevertheless, Mr Barnier’s optimism caused the Pound to strengthen significantly against the Australian Dollar, on hopes of a deal.

Sterling has also been boosted in the last month by positive economic data, including the strongest growth of 2018. In the three months to July 2018, growth rose to 0.6%, up 0.2% from the previous quarter, according to Office for National Statistics data.
Guidance for AUD buyers

There has been a decent rally on GBPAUD after prices finally broke up through the 1.80 level that had been acting as resistance since June. It is now trading at the highest level since May, with the next target being the March high, which comes in around 1.8500.

The relative strength indicator suggests that the Pound is overbought in the short term, so we could see prices drop back to the 1.80 level initially. In the bigger picture, if there are more favourable noises out of Michael Barnier, EU Negotiator, about likelihood of a Brexit deal, we could see a break up through 1.85 to the next critical level (a 50% retracement of the move from the 2015 high at 2.2359 to the 1.5576 low in 2016), which comes in at 1.8967.

A word of caution, we’ve still got a UK government plagued by infighting, hardliners would prefer a no-deal Brexit and that would see the Pound collapse – I don’t think we can get too comfortable with this rally in the Pound. It will evaporate quickly if the Chequers plan is mothballed, so we are expecting more volatility for the foreseeable.

So, if I were buying AUD, I’d buy some at the current level, more on a break through 1.85 and place a stop loss order at 1.80 as a safety net just in case it all goes pear-shaped again…

Guidance for AUD sellers

In the short term, the rally in the Pound may be running out of steam, so it would be wise to place a stop loss above 1.8500 and look to target 1.81-1.8150 on a correction lower. A break below 1.80 and it will fall to the bottom of the uptrend, which comes in at 1.77. Below this level, there is major support at 1.73.

GBPAUD - Research Report Chart - September 2018

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