UK Rate hike still “probable”

Sterling took a well-deserved breather yesterday having scaled the heights to a level that hasn’t been seen since the Brexit referendum twenty-one months ago. Yesterday’s release of employment data was highlighted by a rise in wage inflation which took incomes above prices for the first time in over a year.

Following weeks of irrational exuberance and frankly unwarranted expectation over a rate hike, it was the first time since this speculation began that it had been justified. Ironically the pound fell for the first time in two weeks.

The Bank of England will most likely remove the gloss from a positive pay gap by increasing rates which will be followed by lenders who will increase the burden upon mortgage payers and risk damaging consumer confidence and retail sales data.

The consumer has been the mainstay of the economy as business investment has collapsed following the Brexit referendum and the uncertainty that has delivered.

Today’s inflation report has the potential for a downside surprise as fuel prices have fallen and the pound has continued to rally. It would take a headline below 2.5% for the rate hike to be called into question but even at that level, hawks on the MPC will campaign for a hike.

Dollar takes a breather.

Over the past month or so it has been impossible to write about the dollar without mention of global issues which provide direction. Although global tensions have far from abated, news that the U.S. are in direct preparatory talks with North Korea, China has promised to open its borders to free(er) trade and the U.S. Treasury has stepped back from labelling any single country a currency manipulator means that the domestic agenda and economic data can return as a significant driver.

Yesterday’s industrial production and housing starts reports both provided a little support to the greenback although they were insufficient to see any change in the Fed’s base case expectation for three hikes to take place in 2018.

The source and direction of inflation were favourite topics of Janet Yellen and her successor, Jay Powell appears ready to continue in the same manner which will be music to the ears of some of the “older hands” on the FOMC. Powell is starting to “freshen up” the way the Fed passes on its views and he intends to hold press conferences after each of the eight annual meetings. With permanent members of the Board of Governors, Lael Brainard and Randal Quarles both seen as dovish the outlook for hikes in 2018 looks spot on.

Euro “snoozefest” continues

2018 could really be the year when the common currency comes of age. Its lack of volatility, irrespective of the propensity of the ECB to avoid big issues is mainly due to liquidity. The sheer size of the wall of liquidity is beginning to become self-fulfilling as speculative flows are tending to look for greater value elsewhere. It may be that following Brexit Sterling with no link to the Eurozone will return to the fore.

In 2018, Sterling has been a major performer and it seems to fulfil the basic requirements as to sufficient volatility and diverse influences to satisfy the market. It is, of course, prone to the odd “flash crash” but liquidity will improve.

The ambition of the ECB and the wider Eurozone authorities is for the single currency to be accepted as one of if not the most acceptable reserve currency. Notwithstanding the enormous debt overhang mostly attributable to France and Germany it is starting to look a likely candidate to replace the dollar although long (very long) term China also has ambitions in that direction although it has a lot of work to do on opening its borders.

 

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