Business

Into the (weakening) groove

Brexit is impacting the value of the pound against the dollar and euro
Brexit is impacting the value of the pound against the dollar and euro Brexit is impacting the value of the pound against the dollar and euro

THE action on financial markets in recent days shows that Brexit concerns remain very much to the forefront of investors’ minds. The FTSE 250 index, which is more exposed to the UK domestic economy, was down by around 2 per cent on the week. On currency markets, sterling fell to a new 31-year low (summer 1985) against the dollar, with the pound trading as low as $1.28. Further weakness on the part of sterling was also evident in euro/pound which traded above 86p.

The backdrop of economic and political uncertainty creates an unfavourable environment for investor sentiment and especially for sterling. The official exit process has yet to begin, and there is no concrete date for when this will commence.

EU law provides for a two year time-frame to negotiate an exit, but this may not include a UK/EU trade deal, which could take a number of years to put in place. The outcome of these discussions will be a key determinant of the long run implications of Brexit for the UK economy and also for sterling.

The currency is now on a weakening trend and remains vulnerable to further downside during this period of high uncertainty, including the likely difficulty faced in securing a favourable exit from the EU. Against the dollar the pound could trade below $1.25 before year end, while against the euro it may trade up towards 88p.

There is an additional headwind facing sterling, with the increased likelihood the Bank of England will loosen monetary policy in the coming months. Therefore, this week’s BoE meeting provides some key near-term event risk for the currency.

Governor Carney stated in recent days that “it now seems plausible that uncertainty (related to Brexit) could remain elevated for some time, with a more persistent drag on activity than we had previously projected”.

Therefore, it was his view that “some monetary policy easing will likely be required over the summer”. He stated that the MPC would “make an initial assessment” of its options at this week’s meeting, while a “full assessment complete with a new forecast will follow in the August Inflation Report”.

The market consensus is that the Bank rate will remain at 0.5 per cent this week, though a rate cut cannot be ruled out. The meeting minutes will be closely analysed for insights into what policy easing measures may be introduced and when. Carney has emphasised that the MPC “can deploy a wide range of instruments” in order to meet its inflation and unemployment rate objectives.

Turning to the US, there is a busy schedule. Retail sales have shown a marked improvement in recent months. They are anticipated to pick up in June. Thus, sales could have grown by around 1.5 per cent in Q2, compared to Q1’s minus-0.1 per cent. This suggests that growth in consumer spending has picked up.

Meanwhile, CPI inflation looks to have held at around 1 per cent in June, although the core measure is above 2 per cent. Meantime, industrial production looks set to have picked up in June, after falling in May.

There is a relatively light calendar in the eurozone, where May industrial production is the main release. Weak national level data out last week suggest that eurozone output will have declined in the month. Despite the lack of eurozone data, the markets will continue to be dominated by Brexit and volatility will remain the key feature.