GBP/USD Helped by Weak NFPs, but Pound Direction Hinges on CPI
Fundamental Forecast for the British Pound: Bearish
- The British Pound looked set to decline after NFPs, but the weak report put the selloff on hold.
The British Pound had a tumultuous first full week of 2014, but thanks to the worst US labor market report since early-2011, the Sterling was able to finish near its weekly highs against the US Dollar, closing up by +0.39% after recovering by +0.89% overall from the low on Monday. Aside from the weak December US Nonfarm Payrolls report clouding the picture, an argument for a weaker British Pound in the near-term may be developing.
This past week, UK economic data (surprisingly) came in to the downside of consensus forecasts. Notably, the December UK PMI Services gauge missed estimates (58.8 versus 60.3 expected), suggesting continued strong growth albeit at a relatively slower pace. November UK Trade Balance data showed a wider than expected deficit, and in light of the fact that the British Pound strengthened sharply from mid-November through the end of the year, it is possible that exporters struggled with the elevated exchange rate. Similarly, both November Industrial and Manufacturing Production figures missed estimates.
It’s haphazard to take a small sampling of data to attempt to extrapolate longer-term trends; but what is clear is that UK economic data has pulled back from its apex. A look at UK yields would suggest that further weakness might be ahead in light of what has transpired on the data front in recent days. Similar to what has been happening in the US yield curve, the UK yield curve has flattened over the past week, with the “belly” of the curve – instruments with 3Y to 7Y maturities – shedding the most yield. Whereas this significantly damaged the US Dollar on Friday, no such development has transpired yet in the Sterling.
Since January 3 (one week), the 5-year UK Gilt yield has dropped by -8.6-bps, the 7-year is down -11.4-bps, the 10-year has dropped by -15.1-bps, and the 30-year yield is down by -7.0-bps. This type of price action – where the 7Y and 10Y notes exhibit the greatest nominal change in yield relative to other maturities is very similar to the flattening of the US yield curve that happened from mid-September through mid-October, which occurred alongside US Dollar weakness.
In light of this past week’s data and the softening yield environment, the British Pound enters the week of January 12 on uneasy footing. Indeed, with expectations for a shift in the Bank of England’s forward guidance starting to gather – a lack of policy statement, to lower the Unemployment Rate threshold to 6.5% from 7.0%,produced a rally in the Sterling on Thursday – incoming inflation and labor market data have an increased importance. In fact, considering that it looks like the UK Unemployment Rate will hit 7.0% sometime in early-2014, the BoE needs low inflation data in order to justify extending forward guidance – the policy of keep interest rates pinned low.
Therefore, we are watching incoming inflation data on Tuesday with great anticipation. Notably, the UK Consumer Price Index is expected at +2.2% y/y, below the BoE’s forward guidance circuit breaker of +2.5% y/y. Core inflation in the UK is at its lowest level since late-2009, and confirmation that a relatively stable, if not cooling price environment, might be the green light the BoE needs to turn up the dovish rhetoric at its February meeting. If speculation for a more dovish BoE arises around continued soft data, the British Pound would likely suffer most against the Australian Dollar and Japanese Yen, two of the weakest currencies in the 4Q’13 and 2013 more broadly. – CV
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