Pound Sterling in Skittish Start to the Week, Northern Ireland and Global Risks Cited

Modified: Monday, 16 May 2022 13:43 BST
Written by: Gary Howes

Stock markets in the red
Northern Ireland risks in the spotlight
GBP/EUR, GBP/USD down
But GBP/AUD, GBP/NZD higher

Above: File image of Prime Minister Johnson, by Andrew Parsons / No 10 Downing Street.

The British Pound is underperforming major peers at the start of the new weeks as global financial markets turn red once more and home-grown risks arise in the form of EU-UK tensions over Northern Ireland.

Press reports suggest Prime Minister Boris Johnson will hold a series of meetings in Northern Ireland Monday as the government gets close to introducing legislation before Parliament aimed at easing trade between the rest of the UK and Northern Ireland.

The Government says the EU is not willing to negotiate a meaningful solution to the Northern Ireland protocol that is jamming inter-UK trade and that it therefore reserves the right to take unilateral moves to ease what it views as a crisis.

But the EU are adamant that any such move would be met with a response; thus far unspecified, but almost certainly likely to include legal action and trade penalties.

Adam Cole, Chief Currency Strategist at RBC Capital Markets, is selling the Pound this week, saying risks arising from a potential EU-UK flareup over the Northern Ireland protocol cannot be ignored.

"It seems more likely than not this will happen," says Cole, "taking the UK a step closer to a trade war with the EU."

In addition Cole also says Sterling faces a "heavy week for data in the UK, with some risk of a much weaker April retail sales report (Thursday; consensus -0.2% m/m) as April marked the start of the brutal squeeze on household real incomes."

Furthermore, eyes will be on Bank of England Governor Andrew Bailey and other members of the Monetary Policy Committee who are due to appear before parliament's Treasury Select Committee on Monday.

RBC Capital Markets say the GBP/SEK exchange rate is the best expression for their view that Sterling will go lower and they target a move lower to 12.07 from 12.31 currently.

Turning to global markets, the backdrop is unhelpful with stocks volatile in the short-term but a more entrenched bear market holding formation.

"Subdued global markets translated into a subdued UK pound, a currency that takes its cues from underlying investor tolerance for risk," says Joe Manimbo, Senior Market Analyst at Western Union Business Solutions.

The biggest losers of the day are the New Zealand and Australian Dollars, as well as other risk-sensitive Emerging Market currencies.

The Yen, Dollar and Euro are in demand.

Above: GBP/USD and GBP/EUR are down on Monday, but GBP/AUD is up, highlighting the impact of broader sentiment.

The Pound tends to rise against the former but fall against the latter when market sentiment is poor, as is presently the case.

Global sentiment will remain the predominant theme for FX and weakening stock markets would likely weigh on the key Pound to Dollar exchange rate and Pound to Euro exchange rate.

"Sterling has been hit hard in recent weeks as risk appetite has soured. Moreover, momentum on rate hikes has switched from London to Washington," says Thomas Flury, a Strategist at UBS' Chief Investment Office.

Markets are concerned over a trifecta of risks that include the war in Ukraine, a Chinese economic slowdown and rising interest rates at the Federal Reserve.

All of the above are unlikely to be resolved in the near-term.

"Global equities are in the midst of a bear market that is not yet finished," says Michael J. Wilson, Chief U.S. Equity Strategist at Morgan Stanley. "Macro and earnings data points continue to soften as global economies move toward later-cycle phases."

Further weakness in global markets will inevitably weigh on the Pound and UBS have revised lower their quarter-end GBP/USD forecasts to 1.24 (previously 1.37) for June, 1.26 (1.38) for September, 1.30 (1.38) for December, and 1.33 (1.39) for March 2023.

They also revise higher their quarter-end EUR/GBP forecasts to 0.85 (previously 0.81) for June, 0.84 (0.81) for September, 0.83 (0.82) for December, and 0.83 (0.82) for March 2023.

China is offering mixed signals to sentiment: on one hand Shanghai looks to be easing lockdown conditions, offering hope that the worst of the Covid lockdowns might have passed, but on the other data out of China on Monday was worse than expected.

China reported industrial production was down 2.9% year-on-year in April, a far worse outcome than the 0.4% growth the market was anticipating.

The country's jobless rate rose to 6.1% in April, the highest level since the 6.2% peak seen in the early part of the Covid-19 pandemic in February 2020.

Retail sales plunged 11.1% year-on-year in April, nearly doubling the -6.1% figure the market was looking for.

The decline confirms a significant loss in demand in the world's second largest economy as major population centres are shut down to prevent the spread of Covid.

It is however reported Shanghai is to end its Covid lockdowns and return to normal life in June, amid the economic slowdown.

Authorities said Monday restrictions are to ease in stages; "from June 1 to mid- and late June, as long as risks of a rebound in infections are controlled, we will fully implement epidemic prevention and control, normalise management and fully restore normal production and life in the city," said Shanghai's Deputy Mayor Zong Ming.

A significant upside pulse for the British Pound could follow a major post-Covid rebound in Chinese economic activity, but investors might have to wait well into the second half of the year before a recovery begins in earnest.