Pound Sterling Under Pressure on Norwegian Gas Supply News
- Written by: Gary Howes
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- GBP under pressure
- As Norwegian gas supply slows
- Russia shuts Nordstream 1 for maintenance
- Investors worried it might not restart
- Puts EUR/USD near parity
Image © Adobe Stock
The British Pound was sold widely as UK gas prices surged in response to the closure of a key Norwegian gas production facility.
Norway is the UK's largest source of natural gas and the shutdown of a gas platform has meant the UK’s major Easington terminal has seen capacity cut to about a quarter of its potential.
A halt of the Sleipner field, where the outage started, was extended into Wednesday.
Major UK gas market contracts jumped as much as 27% on the developments, which is far greater than the rise of approximately 5% in the major European contracts.
For all European currencies gas supply matters greatly as surging prices and limited supply threaten to squeeze economic activity.
The Pound's sensitivity to the surge in UK gas prices is reflected by a broad decline against all the majors which confirms a GBP-centric driver is at play:
Above: GBP performance on July 12.
The Pound to Dollar exchange rate fell over a percent to trade at 1.1882, with banks quoting at 1.1550 and independent providers at 1.1850.
The Pound to Euro exchange rate had built on last week's 1.80% gain to extend to 1.1840 but has retreated to 1.1793 bringing bank payments to around 1.1463 and independent payment providers rates close to the market rate at around 1.1758.
Although the Pound is taking a hammering against the Dollar it is looking better supported against the Euro and other European currencies as they too are being hit by significant anxieties linked to the supply of gas.
Although the UK is particularly exposed to Norwegian supply the Eurozone is particularly exposed to Russian supply.
The Nord Stream 1 pipeline, which transports 55 billion cubic metres of gas per year from Russia to Germany, will be shut for maintenance from Monday until July 21.
But, "there are concerns that the outage may last longer than this due to the war in Ukraine," says Thanim Islam, Dealer Manager at Equals Money, "any delays could ultimately put the euro under further pressure."
The fears have culminated in a fall by the Euro to Dollar exchange rate to parity on Tuesday, but those sending Euros into Dollars via their bank accounts have already be doing so at rates well below parity for some time now.
German Economy minister Robert Habeck said he was concerned Russia’s president Vladimir Putin could use the opportunity to stop deliveries completely under some technical pretext.
"Let's prepare for a total cut-off of Russian gas; today that is the most likely option," French Economy Minister Bruno Le Maire said Monday, echoing the fears of his German counterpart.
Above: Europe's major gas import pipelines. Source: ENTSOG, Viscosity Redux.
The price action in currency markets suggests the Pound is once again taking cues from global developments and local data releases following the recent political intrigue surrounding Prime Minister Boris Johnson.
Because the UK gas market is intertwined with that of the EU both UK and EU gas contracts are seeing extraordinary appreciation, squeezing businesses and consumers.
"Recent euro weakening is related to a doubling in regional gas prices. The situation is dynamic but the fallout on EUR from curtailed gas supply would be sobering," says Meera Chandan, global FX strategist at JP Morgan. "Scandis and GBP are less energy dependent, but still expected to weaken vs. USD."
Germany is moving towards a gas rationing regime after the economic ministry last Thursday warned of a high risk of long-term supply shortages due to Russia systematically choking off gas deliveries.
France is also considering drastic action.
"You also have to prepare load-shedding plans, we are doing it," Le Maire also told reporters Monday. "It means looking in a very specific way at each company, each employment area."
Above: GBP/EUR (top) and GBP/USD (bottom) at daily intervals.
Fears of Recession
With the Eurozone's two largest economies likely to see manufacturing output come under pressure as a result of rationing economists are downgrading economic growth expectations.
"The beginning of a 'maintenance period', which is stopping the flow of Russian gas to Europe via Nord stream for 10 days, is focusing attention on the risk of a more protracted Russian embargo which could tip in the Euro area into a recession," says Gilles Moëc, Group Chief Economist at AXA Investment Managers.
As expectations for a Eurozone recession rise expectations for future inflation rates fall as demand slumps.
Above: Euro performance over the past month.
"Our team now look for a Eurozone technical recession in 4Q22/1Q23. This will weigh on pro-cyclical currencies like the euro," says Chris Turner, Global Head of Markets for UK & CEE at ING.
A key measure of inflation expectations - the five-year / five-year forward inflation swap - fell to 1.9898% on Monday, below the 2% target of the European Central Bank, at its lowest since March 02.
Despite falling inflation expectations investors continue to expect a rapid pace of interest rate hikes at the European Central Bank (ECB); OIS money markets show investors are expecting up to 150 basis points of interest rate hikes to come from the European Central Bank by year end.
It was rising expectations for higher ECB interest rates in response to rising inflation that largely underpinned the Euro in the May to June period.
But expectations are now coming down in response to fears of an Eurozone recession and this is reflected by ongoing weakness in the Euro which is closing in on parity against the U.S. Dollar.
This rerating has also been reflected in a higher Pound to Euro exchange rate which had tested lows below 1.15 in June to return to 1.18 at the time of writing.
Beware an Euro Rebound if Nordstream Restarts
But if gas supplies resume as planned the Euro could be in for a sharp recovery says Goldman Sachs.
The bank's economists have downgraded their Eurozone baseline growth expectations for the next year by about 75bp, while also flagging the risk of a more severe downturn if gas flows from Russia are interrupted entirely.
Goldman Sachs' currency strategists use a rule of thumb that a 75bp growth downgrade is typically worth about 1.5% on EUR/USD, so the moves this week are consistent with the market adjusting to this shifting outlook and putting some weight on the possibility of an even more significant growth impact.
"If the market were to move to pricing our severe downside scenario, it could push EUR/USD lower by another 5%," says Zach Pandl, Co-head of FX Strategy at Goldman Sachs.
However, should Nordstream 1 come back on stream as scheduled the relief would likely lift Euro exchange rates.
"We also see room for upside from both a growth and policy perspective. If gas flows resume after maintenance is completed, our metrics suggest EUR/USD could rise by about 1% if the market started to put less weight on these more severe scenarios," says Pandl.
