Tuesday 20 February 2018

Daily Market Update: Sterling at 12-month low vs. the euro; equities and oil prices all under renewed pressure

Fos-Lavera oil hub, France, REUTERS/Jean-Paul Pelissier
Fos-Lavera oil hub, France, REUTERS/Jean-Paul Pelissier

Simon Barry

Yesterday’s commentary noted the tentative signs that recent strong downward pressure on a range of financial market prices, including sterling, equities and oil, had eased a touch.

But those signs of stabilisation have given way to renewed downward pressure in all three cases over the past 24 hours or so. Notably, sterling has weakened sharply on the exchanges with a near 2% move to the downside against the euro taking the pound to fresh 12‐month lows this morning of 77.5p.

Yesterday’s UK inflation data if anything had a slightly stronger than expected hue to them, with core CPI inflation rising to an 11‐month high of 1.4% rather than remaining unchanged at 1.2% as has been expected (the headline measure was in line with forecasts at 0.2% y/y). Rather the catalyst for the latest bout of sterling weakness came in the form of a speech from BoE Governor Mark Carney. In a comprehensive overview of his views on the UK economic and policy outlook, Carney set out his current thinking on the broad contours of the interest rate debate. Carney indicated that the Bank needs to see “cumulative progress in three areas to have reasonable confidence that inflation is on track to return to the target and that a modest tightening in monetary policy will be necessary to ensure it does so sustainable.

This means: sustained momentum relative to trend; domestic cost growth resuming a path consistent with headline inflation at 2%; and core inflation measures moving notably towards the target”. His overall view is that “since last summer, progress has been insufficient along these dimensions to warrant a tightening of monetary policy”. While he highlighted accelerating household spending growth, solid employment growth, and a gradual improvement in the euro zone, he also referenced some recent slowing in UK overall GDP growth, a weaker world economy and the oil price collapse as restraining influences on the all‐important UK inflation outlook. His conclusion is that, all told, recent developments suggest that “the firming in inflation pressure we had expected will take longer to materialise”.

Pushing out the timing around the expected pick‐up in inflation to target is central bank speak for pushing out the timing of any required policy tightening of course. And so Carney’s comments have understandably been taken as a dovish update on the policy outlook, with any near‐term tightening of the policy stance now looking extremely unlikely. But one question not addressed by Carney’s speech yesterday was whether current expectations in financial markets lie in the same ballpark as the Bank’s view on the possible timing of the normalisation process. There was a further pull‐back in market expectations after Carney’s speech yesterday, the result being that markets don’t now see the first hike in official rates coming until the second half of next year.

In fairness, it does look as if there will be less support for sterling from interest rate policy this year than we had expected. And there’s much uncertainty around the UK and global outlook at present. However, we are reluctant to fully buy into current interest rate expectations in UK markets which look somewhat overdone in our view. So while momentum could take sterling weaker still in the short term, we would be surprised if the pound doesn’t recover at least some of its recent losses in the coming months (Eur/Stg was trading sub‐70p as recently as mid‐November). This is especially the case seeing as some of the same forces restraining UK inflation are set to influence the eurozone and ECB too, though a sustained move higher for sterling also likely needs a reduction in Brexit uncertainty.

Elsewhere, another ugly day for Asian stock markets saw the Shanghai Composite lose a further 1% while the Nikkei was even weaker, dropping by 3.7%, in the process taking its sell‐off into bear market territory. And oil prices are very much on the back foot again, coming very close to new lows at under $28pb again this morning. While there wasn’t any dramatic new fundamental news, we did have a couple of reminders of some prominent themes: the IMF having downgraded its forecasts for global growth by 0.2pp for both 2016 and 2017 and the latest IEA forecasts highlighting that global oil supply could exceed demand by 1.5 mb/d in the first half of 2016.

At home, the latest official figures on Ireland’s debt and budget deficit serve to highlight the benefits of an improving economy for the public finances, with the debt to GDP ratio falling back to below 100% in q3 of last year for the first time in over four years.

Looking to the day ahead, the monthly labour market report is published in the UK. Expectations are for a bumper 235k job gain in the 3 months to November (which would represent the largest 3 month increase since February 2015) following 207k in October and for the 3 month average unemployment rate to remain at 5.2% in November. However, despite recent encouraging employment trends, upward pressure on wages has slipped in recent months – with Bank of England Governor Mark Carney going as far to note that the easing “gives pause to the inference that the labour market is as tight as would be suggested by the drop in the unemployment rate alone”. The close of 2015 sees wage growth encounter challenging base‐effects so both total average weekly earnings and average weekly earnings (ex‐bonuses) are expected to decelerate in November. Expectations are for a fall from 2.4% to 1.8% 3m/3m in total average weekly earnings and for a slip from 2.0% to 1.8% 3m/3m in average weekly earnings (ex‐bonuses).

In the US, core (ex. food & energy) CPI inflation is expected to edge up to 2.1% y/y in December following 2.0% in November. While not the Fed’s preferred measure of inflation, this is a useful indicator of underlying price pressure and a 2.1% y/y reading would represent a 0.5 percentage point pickup from a year earlier – an indication of some underlying upward pressure on core inflation. Expectations are for headline CPI inflation to also accelerate (mainly due to supportive base‐effects linked to significant energy price declines towards the end of 2015) from 0.5% to 0.8% y/y. Housing starts are expected to increase by 2.3% m/m in December following a 10.5% gain in November while a 6.4% m/m decrease in building permits is expected as payback for a 10.4% surge in November.

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