While I wouldn’t describe myself as a Sterling (Stg) sceptic, I have to confess that back in January my forecast for the beginning of Q2 2015 was that Stg would be trading around the .8000 level, a spectacularly poor call when compared to today’s .7150.
Where did I go wrong?
Looking back at the article I wrote in January, I forecast that the economic factors were on balance likely to be slightly supportive of the pound. However this has not really transpired, the following indicators have disappointed with the exception of the unemployment rate:
- Q1 GDP comes in at +0.3%, expected +0.6%
- The construction sector has shrunk in two of the last three months
- Consumer price inflation has been zero for two months in a row
- Average weekly earnings (ex bonuses) have come in at 1.8% for the three months to February – remaining stubbornly below 2%, not to mind the Bank of England’s forecast of 3.5% for 2015.
- UK Retail sales fell 0.5% in March giving up most of February’s 0.6% rise.
- UK unemployment rate drops to 5.6% for the three months to February 2015, the lowest rate since 2008.
The economic indicators out of the UK in Q1 have been uninspiring; some might even say they were disappointing. Certainly apart from the unemployment rate, none of the indicators were supportive of the pound.
The unemployment rate is the one economic indicator that is out -performing, hurtling towards the Bank of England target of 5.3%. It is undoubtedly the star performer in the UK’s economic locker, however one suspects that the unemployment rate alone is not enough to explain the more than 10% increase in the pound against the Euro in Q1.
The chart below is the economic surprise index and measures data surprise relative to market expectations. A positive reading means that data releases have been stronger than expected and negative reading means that data releases have been worse than expected
The performance of the Euro is undoubtedly a significant factor, as the currency collapsed against the majors in January, losing 8.6% against the dollar between the 5th of February and the 12th of March and 6.94% against the Yen between the 11th of February and the 13th March.
So it’s no surprise given the weakness of the Euro that the pound has strengthened against the single currency, the surprise is that it has maintained this strength while the Usd and the Jpy have given back some of their gains. It is also a surprise to see Stg as strong as it is with less than ten says to go the British election.
UK election – sell the pound?
My central argument going back to mid 2014 is that Stg would weaken into the general election. My thinking (undoubtedly flawed) was that political uncertainty, the prospect of a hung parliament and one alternative – a Conservative victory with its promise of a vote on Europe would all serve to weaken the pound. Why have we not seen an exodus from the pound? I can think of two possible explanations – the first is that a hung parliament in all probability defers any vote on Brexit for good or at least to the distant future.
The second explanation is that I was not alone in thinking that the pound would be entering stormy waters ahead of the general election and that to short Stg was the obvious trade! I suspect this is a crowded trade and the market may well be very short of Stg, if this is the case then that may explain Stg’s strength against a recovering Euro Zone.
So what are Eur/Stg prospects for the remainder of Q2 and into Q3?
I think the following factors will come into play:
- The outcome of the general election – likely hung parliament and Stg neutral given the comments above
- Quantitative easing is likely to copper fasten the Euro Zone recovery – giving some support to the single currency
- The Greek situation – the markets are convinced that a solution (fudge in the best European tradition) will be found – could provide a relief Euro rally
- I believe the UK economy recovers from it’s Q1 slowdown and meets growth forecasts of 2.5% this year – Stg supportive
- The market quickly unwinds it’s short Sterling positions after the election – initially Stg supportive but longer term removes an obstacle to Stg weakness
I think a resolution of the Greek issue and continued improvement of the Euro Zone economy will the key drivers for Eur/Gbp in the months ahead. I see Eur/Gbp trading a range of .7000 to .7410 for the remainder of this quarter, moving to the top of this range as we enter Q3. The big danger to this forecast is political risk, the Greek situation and an unexpected outcome in the UK elections.
As ever if either you agree with my forecast or if you have an alternative viewpoint as to where Eur/Gbp will trade in the months ahead, I would love to hear from you.