Sterling and What to Watch For

Until some fundamental questions are answered, sterling is likely to remain static against the euro in particular. Sterling ended the first quarter lower than it had started against only 4 currencies: the Norwegian krone, the South African rand, the Japanese yen and the Mexican peso making it one of the best performing major currencies in the first quarter of 2018. But how is it likely to fare during the course of the second quarter?

Three things that will determine how the pound will fare over the next 3 months are the Bank of England meeting in May, inflation and job numbers growth, and the continuing Brexit deal.

Following the announcement of a transitional Brexit deal in March, most analysts seem confident that the Bank of England will raise interest rates at its meeting on May 10th. Currently, markets are pricing in a 77% chance of the base rate increasing to 0.75%; the highest since February 2009. While that level of expectations means that markets are unlikely to drive sterling much higher on the chances of a rate hike alone, the inflation report and minutes of the meeting will charge thoughts of additional increases in the Bank of England’s base rate later in the year. If the language coming out of this meeting point to a rate hike later in the year, sterling is likely to push higher.

The Bank of England believes that pay will start to outpace inflation through the coming year and real wage gains are the silver bullet for the UK economy at the moment. Real wage growth is significant because it relies on optimistic employers being happy with business conditions, it allows
consumers to re-balance spending figures from credit uptake and it promotes growth in generalised output with a central bank more comfortable to normalise monetary policy. Unemployment is higher in absolute terms but by not enough to drag the unemployment rate up; more people are
joining the labour market and inactivity is at the lowest level since 2012. Perhaps most significantly, a return to real wage growth would be a further fillip for sterling as investors would in all likelihood see this as boosting future growth and inflation prospects.

As for Brexit and its influences, we now have a transitional deal that allows for more time but actually does little to influence the outcome of the decisions that need to be made or what happens in the background while this is all going on. There are questions that need to be answered. Some of these include trade, the UK withdrawal bill, the ongoing political situation in the UK and Northern Ireland. Until some of these fundamental questions are answered sterling is likely to remain static against the euro in particular.

 

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