How much of Labour’s post-Brexit take on EU trade is too much for the market? We still don’t know for sure but the market gave a nod of support after Labour backed a customs union.
To be clear, sterling’s 100-pip move was made almost completely before comments by Labour leader Jeremy Corbyn. The pound had given back almost all of the gain within a couple of hours. That shows the substance of Corbyn’s comments did not add anything to pre-speech briefings last week. Pronounced sterling slippage later on Monday also pointed to the lack of a Labour magic bullet that could change arithmetic around government chances in votes on customs and trade later this year. The arithmetic raises the prospect of a government defeat, whether any vote is designated as a confidence vote or not. But given Downing Street has delayed some votes that were initially to be held in March, calculus is now less precise.
Stocks welcome lack of detail
For the same reason, with only fuzzy logic to go on, after Labour’s clarification on customs, British stocks, particularly blue chips looked through their long-standing inverse correlation with sterling. The FTSE rose with cable all session. A less buoyant pound showing versus euro on Monday, against which it more than erased all gains, also reveals much apparent sterling strength is in fact borrowed dollar weakness. Corbyn’s speech was not after all a one that offered much detail – including on how Labour will sidestep political opposition to ‘regulatory divergence’ on the island of Ireland. But detail was hardly the point. With no trade deal surprises, dual-purpose comments aimed politically and at business were a bigger takeaway. Decrying Prime Minister Theresa May’s “rigid” approach for instance, Corbyn noted risks to exporters if tariff-free trade were lost.
Sterling was already well-buoyed by the greenback’s reversion to softness following a five-session rally, as the market positions for potential unknowns in new Fed chair Powell’s first testimony to the House Financial Services Committee. The second day of Powell’s testimony will coincide with an update on the Fed’s supposed ‘preferred inflation gauge’ the Personal Consumption Expenditures Index. Chances that Powell could deliver another ‘inflation shock’ like the one triggered by faster than expected wage growth earlier this month are distant. But the market’s lack of familiarity with the new Fed chair has helped bring renewed dollar selling. An apparent hawkish transition in weekend press comments by the newest member of the Bank of England rate-setter, Sir David Ramsden, also helped sterling off to a firm start.
Breathing space for May
Still a week that started with a focus on one side of the UK trade debate will end with another. Theresa May is scheduled to speak about Britain’s post-Brexit ties with the EU on Friday. We see little scope for revelations, particularly given that key parliamentary votes have been delayed till later in the year. FX volatility is nevertheless inching higher, as protection is bought ahead of Italy’s election on Sunday. Before that, U.S. ISM and UK CIPS manufacturing PMIs can intensify swings as retracement of the pound against the dollar off its post-Brexit high approaches closely scrutinised prices near $1.3835. The rate is where sterling’s recent up leg kicked off. A break lower would imply weakened support. In turn that could undermine the narrative around sterling’s recovery. We think a bounce is more probable, particularly if economic data due later this week confirms that inflation is falling in supply chains as the pound firms up.
GBP/USD price chart – daily intervals
Source: Thomson Reuters and City Index