The promise of improvement

​​​​​​Today's news headlines:

  • ‘Johnson faces diplomatic dilemma over Russia parade’. Boris Johnson is considering an invitation from Russian President Putin to attend a parade in Moscow to mark the 75th anniversary of the end of the second world war. Relations with Russia were tarnished in 2018 following Russia’s attempted assassination of a former agent, Skripal, in Salisbury. The decision will signal how the new Tory government wishes to proceed with relations with Russia. (Financial Times)
  • ‘Germany starts to shake off slump with better start to 2020’. Germany has started the New Year with a pickup in business activity as the Composite Purchasing Managers’ Index posted a five-month high on Friday morning. The data is partly a reflection of easing trade tensions between the US and China, but Europe still faces the risk of direct trade tensions with the US after Trump once again threatened levies on cars—a key part of German industry. (Bloomberg)

A question of timing

Most of the time, interest rate decisions are signalled well in advance, which means the subsequent press conference is screened for minor differences in tone and wording to judge future policy. Well, the Bank of England’s decision next week has swung wildly between no chance of a rate cut and near certainty of a cut. The reason for all of this drama is Brexit. We’ve continually highlighted the steep decline in UK fundamentals at the end of 2019. Although the landslide Tory victory in the December general election has created a sense of confidence in a Brexit conclusion, the ability for this momentum to impact underlying growth is less certain.

Just this morning, we’ve seen another series of positive data points, UK Service and Manufacturing Purchasing Managers' Index survey data came out much better than projected. The services reading shows a distinct return to expansion at 52.9, versus the start of the month, which registered a 50.0 neutral level. The manufacturing number was still in mild contractionary territory at 49.8 but much better than the previous reading. Sentiment is all well and good, but the real test will be whether output data in a few weeks fulfils the survey’s promise of improvement.  

Bottom line: After all is said and done, Bloomberg suggests the probability of a rate cut sits at 45% for next week's meeting and nearly 100% by the June meeting. At this point in the Brexit story, it is particularly difficult to call the direction of growth, but taking a step back tells you this isn’t that crucial. It seems likely the UK economy will need a helping hand whether it's this meeting or three meetings from now. If Boris Johnson can make rapid forward progress in trade negotiations and ratchet up business investment, it might reduce the Bank of England’s urgency and degree of policy action employed during 2020. Mostly, it’s a question of timing.

GBP/USD

The pair traded flat yesterday as markets awaited Friday’s UK PMI readings—an important release for investors to finalise their expectations of the Bank of England’s monetary policy decision next week. The pair remained bound between 1.31 and 1.3150 level before the release beat expectations. While the data failed to keep the GBP/USD exchange rate above the range, it may support the pair throughout the morning. Further volatility may come this afternoon with the US PMI release.

GBP/EUR

This morning, the currency cross tested the 1.19 level after the Euro Index continued its downward trend, and the Sterling equivalent ticked higher. This morning’s better-than-expected UK PMI release briefly lifted the pair above the 1.19 figure before falling back to pre-release levels. With all the key UK and European data already released for today, continued Euro weakness may be the prime supporting factor for the pair throughout the day.

EUR/USD

The common currency continued its downward trend as the trade-weighted Euro Index broke below its recent 10-week trading range, and the Dollar Index continued its January recovery. The pair quickly pared gains following mixed European PMI’s as markets now await the US PMI release this afternoon. Yesterday’s move downwards puts the pair below the 100 daily moving average—a level that may provide short-term resistance.