British Pound Assails 1.35 Against US Dollar, Slips to Euro as Curtain Closes on 2017

Pound-Dollar breaks 1.35. Pound-Euro flatlines at 1.1254 after EUR/USD surge. Italian election, economics and a weak Dollar are all in focus. 

The Pound advanced on the Euro and US Dollar in London Friday, breaking through the 1.35 level against the greenback, amid low volume trading in the final session for the 2017 year.

A weak Dollar remains the dominant theme in the foreign exchange market more than a week after President Donald Trump signed his much vaunted tax bill.

Last week’s bill, set to be made law at some time in January, has seen the greenback snubbed by traders and has helped to lift the Pound-to-Dollar rate back toward its December highs.

The Euro also surged ahead against the US currency Friday, despite having several days of rapid acceleration already in the bag, which now sees the common currency threatening a challenge to its 2017 high of 1.2092.

News-flow around the Euro has been mixed in the last 24 hours.

Italian President Sergio Mattarella formally dissolved parliament on Thursday, clearing the way for Italy’s general election to be held early next year. Prime Minister Paolo Gentiloni and his cabinet have since set the date of March 04 for the vote.

The ballot marks the last major political challenge for the Euro in the current election cycle but, in the short term at least, is also seen as a threat that could see the common currency carrying a renewed risk premium over the coming months.

Establishment parties and rivals from both the political right and political left will fight it out for the top spot in Italian politics.

The most feared outcome for markets is for the Five Star Movement (M5S) to emerge from the vote on top with a vote share of more than 40%.

This would be enough to see it gain a “majority premium” of bonus seats, or voting rights, in the Italian parliament - enabling it to form a government and implement its policy agenda.

Opinion polls have placed M5S as Italy's largest party, with around 29% of the vote, consistently throughout much of 2017.

A core part of the M5S policy platform is a renegotiation of the European treaties, particularly the rules on budget deficits, and a potential referendum on Italy’s use of the Euro if the talks fail.

However, on a more positive note for the currency, German inflation was shown falling by less than was expected over the course of December, according to preliminary data from Destatis.

Rising inflation in Europe’s largest economy is of course important for the Euro because it is the raison d etre for current European Central Bank monetary policies of ultra-low interest rates and quantitative easing.

The central bank can only contemplate a full exit from QE and an eventual increase in interest rate when inflation shows signs of making a sustainable return toward its 2% target.

The Pound-to-Dollar rate was marked 0.58% higher at 1.3519 around the London close Friday while the Euro-to-Dollar rate was quoted 0.62% higher at 1.2012.

With EUR/USD having overtaken the Pound-to-Dollar rate late in the session on Friday, the Pound-to-Euro pair reversed an earlier gain to trade 0.04% lower at 1.1254 around the time of the London close.

Above: Pound-to-Euro rate shown at hourly intervals.

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Economic Data: What to Watch

The final trading day of the year saw consumer prices fall by less than was expected in Germany, but by more than was forecast in Spain, a week ahead of December’s “flash” reading for the Euro block overall.

German headline inflation fell by just 10 basis points to 1.7% during December, when consensus had been for a 20 basis point decline to 1.6%.

Spanish inflation, on the other hand, fell by a considerable 40 basis points to 1.2%. This was down from 1.7% in November and came against a consensus that had economists expecting a more modest decline to around 1.5%.

“The core inflation rate is moving sideways, disregarding the small hump in the spring, caused mainly by a price leap in package tours and hotel accommodation,” says Dr Christoph Balz, an ecoomist at Commerzbank.

Headline consumer price inflation has remained subdued around the 1.5% level for the Eurozone overall during recent months while the more important core measure, which removes volatile food and energy items from the goods basket, has fallen by a fraction.

Core-inflation dropped from 1.2% in July to 0.9% in October and remained beneath the 1% threshold throughout November. 

Hopes of a complete exit by the ECB from its QE program, and an eventual rate rise, will be the dominant themes for the Euro in 2018. 

“Still moderate wage growth, for its part due to still high unemployment in the eurozone, speaks against a lasting upward trend in the core inflation rate. An interest rate rise by the ECB is thus unlikely to be on the agenda before the summer of 2019,” Balz adds.

Friday’s Eurozone data comes just days ahead of the next volley of IHS Markit surveys of purchasing managers across the UK manufacturing, construction and services industries, which will provide an important insight into the likely performance of the UK economy during the final quarter of the year.

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Brexit: Where Are We?

European negotiator Michel Barnier laid out the Commission’s draft guidelines for the next phase of Brexit negotiations Wednesday, 20 December, building on those issued by the European Council the Friday previously.

Much of the draft statement was a reiteration of the details given by the Council Friday but Barnier did say that any “transition” period would need to come to and end on December 31, 2020, at the same time as the current European Union budget comes to an end.

The statements also cast fresh light over the scope for deadlock in talks to emerge once into the New Year, with Brussels insisting that the future relationship can only be agreed in outline before the UK enters transition, with the bulk of a final deal to be struck after March 2019.

The withdrawal agreement, entitling the EU to substantial payments and bestowing various other obligations on the UK, must be legislated for ahead of the UK’s departure. Bariner also threw down another hurdle to the UK government.

“Legally speaking, mechanically, the day after the U.K. has left the EU institutions, the U.K. will no longer be covered by our international agreements,” he said at a press conference. “They will be leaving approximately 750 agreements, which we have signed.”

If proven to be correct then this, combined with third country status in transition, could become a stumbling block for the government if it folds on its earlier demand the UK be able to strike trade deals while in “transition”.

Any constraint on being able to enter into deals before the transition ends could mean the UK is unable to renew and therefore, temporarily excluded from, the existing trade agreements the EU has with other countries.

That said, the documents released last week bore signs of a possible softening in Brussels stance on this point.

“Where it is in the interest of the Union, the Union may consider whether and how arrangements can be agreed that would maintain the effects of the agreements as regards the United Kingdom during the transition period,” the draft document says.

Separately, but also last Wednesday, the UK government folded to opposition MPs and rebels within the Conservatives’ own ranks when it agreed another amendment to the European Union Withdrawal Bill.

This latest amendment allows UK lawmakers to defer the date at which the UK leaves the European Union, scuppering the government’s attempt to place a firm departure date into law.

It follows another amendment that gave parliament the power to reject the final Brexit deal negotiated by PM May and her ministers, effectively delaying the UK’s departure while another attempt at negotiation is made.

“Recent developments in the Brexit negotiations continue to support our view that the UK is ultimately headed for a softer Brexit. This is likely to provide ever more support to our constructive view on sterling which we have expressed through higher GBP/CHF,” says Kamal Sharma, a strategist at Bank of America Merrill Lynch.

BAML's Sharma is not alone in flagging a "soft Brexit" as likely because the "softest of all possible Brexits" was also forecast recently by strategists at BMO Capital Markets.

Another round of Brexit talks will begin in January, the focus of which will be a deal concerning transition to the new relationship.

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UK Consumer Outlook Clouds into Year-end

The Confederation of British Industry Growth Indicator rose to +19 in December, up from a year-long low of +6 in November, as all sectors enjoyed a boost ahead of the festive period.

Thursday's survey polled 642 businesses across distribution, manufacturing and services asking them to rate current levels of activity and expectations for trading once into the New Year.

On the downside, the forward looking segment of the survey shows sentiment among CBI members taking another southward turn once into the New Year as the inflation squeeze continues to pressure household budgets and firms fear the uncertainty around Brexit.

The discussion around retailers and the economy is noisy and the outlook clouded going into year end, with conflicting signals coming from various indicators of consumer spending in recent weeks.

Thursday, 21 December, saw the GfK measure of consumer confidence sink one point to a fresh four-year low of -13 for December.

“It has been a slipping and sliding year. The Overall Index Score has slipped from - 7 in January to -13 in December – and not a single positive score in between,” says Joe Staton, head of market dynamics at GfK.

In fairness, the GfK consumer confidence measure hasn’t posted a positive score for more than two years despite the economy having enjoyed its strongest post-crisis expansion in 2015, while also holding up well throughout 2016.

An overwhelming majority of that growth was powered by consumer spending, which has held up reasonably well of late, according to official measures of output.

National accounts data released Friday, 22 December, showed consumer spending rising at a rate of 0.5% during the three months to the end of September, up from the 0.2% growth seen in the second quarter.

The previous week, Office for National Statistics data showed consumer spending rising by 1.1% in November, when compared with the month before, while annual growth was close to 2%.

These numbers were far ahead of the consensus for more muted month-on-month growth of 0.4%, and largely the result of Black Friday promotions.

However, some have begun to suggest consumer spending might moderate a touch during December and subsequent months. Wednesday 20's Confederation of British Industry Distributive Trades survey is the latest example.

“Retail sales volumes saw a second month of growth in the year to December, but this disappointed expectations of stronger growth. Sales are expected to rise at a similar pace in the year to January,” the CBI wrote in its report on Wednesday, 20 December.

The Distributive Trades survey polls 109 firms, 56 of which are retailers, who account for more than a third of all employment in the retail sector. It asks firms to state whether sales have risen or fallen and how actual results have compared with expectations.

“37% of retailers said that sales volumes were up in December on a year ago, whilst 17% said they were down, giving a balance of +20%. Growth was slower than expected (+30%), and slightly slower than in November (+26%),” the CBI said Wednesday.

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