Euro Weekly 26 October 2018

GBP: At the end of last week, the market was taking the PM at her word that the Brexit deal was 95% settled, although the final 5% looked largely centred on the thorny issue of the Irish border and caused some concerns. This week, Theresa May exhorted MPs to “hold our nerve” in the closing stage of negotiations with the EU. Investors did not listen to her request; before, during and after her speech they wrestled the pound lower, such that it fell by an average of 0.6% against the other major currencies. Investors did, however briefly, get excited about a story that the EU might offer Britain a customs union. The problem is how to sell that union to parliament, which stopped the optimism pushing the pound higher for long. All the political uncertainty is starting to take a toll. The Confederation of British Industry’s Industrial Trends Survey and the Richmond Federal Reserve’s Manufacturing Index survey were both lower on the month. The CBI’s measure was down from -1 to -6 and the Richmond Fed’s from 29 to 15. The result are symptomatic of a general economic twitchiness. Trump’s trade war, Merkel’s electoral erosion, Conte’s budget, Xi’s slowing growth and of course May’s Brexit are just a few of the factors that are combining to undermine sentiment.

EUR: On Friday evening Moody’s lowered its rating of Italy to Baa3, one step above junk. The move was not unexpected, in view of the heated argument between Rome and Brussels about Italy’s 2019 deficit budget and the way the market has shunned government bonds in the last couple of weeks. The threat of an Italian debt crisis, together with some concern over the prospect of a no-deal Brexit did harry the euro this week. Despite this, the ECB stated that the central bank would be maintaining its planned course. Analysts expect any shift to come after the ECB has updated macroeconomic projections in December – which means any upcoming ecostats will be examined closely for signs of change. Currently the ECB remains committed to ending QE in December. While there were some concerns and the growth outlook is darkening somewhat. ECB President Mario Draghi played down concerns speaking at a news conference he said, “We’re talking about weaker momentum, not a downturn,” and confirmed that policy makers felt that growth risks were “broadly balanced”.

USD: The uncertainty of the Midterms and even the bomb threat to leading Democrats has done little to upset the US dollar which is continuing to ride high in the market. Investors are starting to look further forward and expect that a correction may be coming in 2019. Markets may currently be ignoring the elections, but the chances are that if the Democrats do effect a ‘blue wave’ across the divided nation, then those changes may start to kick in before the end of the year.

CAD: Canadian retail sales fell 0.1% in August and inflation slowed to 2.2% from 2.8%. Every one of the components was lower than forecast and their effect was to raise question marks about the BoC’s determination to push ahead with the expected interest rate increase this week. In the end, however, the expected rate of 1.75% was announced. However, the tone of the statement was considerably more hawkish than investors had been ready for, especially the comment that “the global economic outlook remains solid”. Although not all investors shared the bank’s optimism they felt obliged to mark the currency higher.

AUD: A by-election in Australia at the end of last week to replace Prime Minister Malcolm Turnbull, delivered an independent to fill his shoes. It means Scott Morrison’s coalition has lost its one-seat majority. However, the new MP has said she would not go against the government in a confidence vote so the Aussie is not unduly troubled. It was 0.4% lower against sterling on the day, unchanged against the Swiss franc and US dollar. There is much greater concern about China – the state of its economy in a trade war environment and the possible escalation of that war.

NZD: The ongoing trade war is also a cloud over the New Zealand dollar, and the impact was slightly stronger for the Kiwi than the Aussie, perhaps due to the reliance on exports and the smaller economy making the trade war environment a large concern.

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