View from the Trading Desk:

Prior to the pandemic, Brexit was the ever-present dark cloud hanging over the British economy and perennial drag on the Pound – and quite frankly, we were all exhausted by it. Then came Boris Johnson’s eleventh-hour deal, and hope fleetingly returned. Now, with the UK’s political situation more fractured than ever and the Northern Ireland protocol stifling trade, Brexit is back in focus as Rishi Sunak looks for a long-term solution to the problem.

The problem boils down to the Northern Ireland protocol, which means an effective customs border in the Irish sea. Goods arriving from Great Britain to Northern Ireland are subject to physical checks, creating a new burden of extra paperwork and customs procedures. This has disrupted existing trade between the UK and EU and reduced opportunities for new trade between the two regions. Also, without the free movement of labour, we have seen a shortage of skilled workers coming into the country. A problem, that CBI Director-General Tony Danker claims, is adding to the ‘stagflation’ pressures in the UK economy. Meanwhile, the Office for Budget Responsibility estimates that Brexit will lower Britain’s trade intensity by 15% over the longer term. 

The latest suggestion in the media is that the UK might adopt a ‘Swiss-style’ arrangement with the EU, a move which would certainly anger hard-line Tory Brexiteers. Switzerland participates in the single market for most goods through its European Free Trade Association membership. But it also has to accept the free movement of labour and must make annual payments to the bloc’s budget.

We have certainly seen signs that Sunak’s administration is trying to soften its approach to relations, following years of fractious rhetoric from both sides. However, the prospect of closer UK-EU ties will be difficult for both Sunak and Hunt to navigate. We would certainly see an internal revolt from senior figures inside the Conservative Party if they were to push forward with effectively re-entering the single market. Still, if a compromise can be made where the UK can remove most trade barriers without entering the single market, we might finally see an end to the saga.

Bottom line: While the UK government certainly needs to find a more palatable solution to its long-term relationship with the EU, it also needs to start forging better trade deals with the rest of the world. With the latest UK growth projections signalling recession throughout 2023, it’s difficult to see too much upside for the Pound in the near term after the recent US Dollar correction. As a side note, it’s worth mentioning that markets are expected to be quiet this week, with limited data, Thanksgiving in the US and the World Cup currently underway. That could make for some choppy price action driven by short-term flows.

The week ahead

GBP 

The Bloomberg Pound Index has gained 0.70% since the start of trading last week following the release of the Autumn Statement by Chancellor Jeremy Hunt on the 17th. While markets welcomed the changes to the UK’s fiscal policy, the year ahead for the debt market could spell further deterioration as the Bank of England begins offloading securities into the market. This is creating some unease as to whether the pace of investment into UK gilts can keep pace with supply, posing the real threat that government borrowing could continue to get more expensive. The Pound is holding onto gains made in the last month against the Dollar, but with Brexit back in focus, there is a question of how long this stability will last. 

• UK Public Sector Net Borrowing is forecast to be £19.1B for the month of October. 
• UK flash Manufacturing and Services PMIs for November will be published on Wednesday; readings of 45.8 and 48.0 are anticipated. 
• UK Chancellor Jeremy Hunt is due to testify before the Treasury Committee on Wednesday regarding the Autumn Statement. 
• Monetary Policy Committee members Huw Pill, David Ramsden, and Catherine Mann are due to speak throughout the week. 

EUR

The Euro is trading just below the $1.0250 handle against the Greenback this morning as concerns that a winter recession in the Eurozone is likely, as demand slows and inflation continues to bite. According to some analysts, interest rate hikes by the European Central Bank are beginning to curtail demand, with preliminary forecasts suggesting a 0.5% GDP contraction is on the horizon for the fourth quarter of 2022. The ECB’s Chief Economist Philip Lane indicated that a smaller increment hike at the banks’ meeting in December is warranted. Record-high inflation will likely push the ECB to continue its hiking cycle into 2023; some anticipate hikes to cease in February. 

• France flash Manufacturing and Services PMIs will hit the tape this Wednesday; analysts expect readings of 47.0 and 57.6, respectively. 
• Germany will also release preliminary PMI data; forecasts are for 45.0 and 46.2 prints for Manufacturing and Services. 
• The German ifo Business Climate survey will publish data on Thursday with an 85.0 print forecast. 
• The European Central Bank will release minutes from its October meeting this Thursday. 

USD

Dollar gains have returned in the last week, with the DXY Index trading marginally below the $108 level after a retracing from multi-decade highs at the end of October. Questions around peak Federal Reserve hawkishness are beginning to feed through markets as investors become the most bearish on the Dollar since July 2021 as short positions swell. Shorts on the Pound and Japanese Yen are also being reined in as uncertainty around the economic backdrop falls. Fed speak is also turning less hawkish as FOMC members voice their preference for smaller hikes at future meetings. US equity futures are pointing lower today as markets weigh the impact of China’s move to lock down areas of the country following further Covid outbreaks. 

• The Richmond Fed Manufacturing Index is expected to read -8 in November, which will be released on Tuesday. 
• Federal Open Market Committee members Loretta Mester, Esther George, and James Bullard are scheduled to speak this week. 
• US Durable and Core Durable Goods Orders MoM for October will be published on Wednesday; 0.4% and 0.0% readings are forecast. 
• Flash Manufacturing and Services PMIs for November are anticipated to read 50.0 and 48.0.

 

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