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3rd November - Why the rate hike weakens the Pound

06 November 2017

TECHNICALS:

MONTHLY CHART

The most compelling chart of the Sterling against one of the majors is that against the Dollar.

A very large multiple top has completed.

The rally back to the band of resistance from the successive lows is now testing that reistance.

Is there any evidence of the rally failing?

DAILY CHART

This short-term chart is full of that evidence.

1.Note the cluster of fibonacci resistances just beneath 1.37 where the rally topped out.
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2.Note the clearly-defined bear rising wedge that is on the point of completing.

Watch then, for a break and close beneath that rising diagonal today beneath 1.3057 or so to signal as fresh bear leg down driven by the continuation bear wedge.

FUNDAMENTALS:

The Bank of England delivered on the much-anticipated rate hike today, the first hike in 10 years. But, far from supporting the Pound, the exact opposite occurred: the Pound sold off against the Dollar and Euro. Why?

The Bank of England has acted against a very difficult backdrop. On the one hand the economy has slowed in the last 3 or 4 quarters to an annual rate of GDP growth of just 1.5%, but inflation sits, as measured by CPI at 3.0% and rising.

To make matters worse, productivity growth in the economy is weak and has been for a number of years. Prior to the Brexit vote economic expansion was sustained by a growing population driven by immigration.

Since Brexit immigration has slowed and if the Prime minister’s pledge is to be believed, it will slow further. The result is unless productivity can be increased, the Bank of England believes the rate at which the economy can grow with out driving inflation has fallen from around 2.3% to the current 1.5%.

However, although productivity is weak, so too is wage growth. The current rate of average earnings is around 2.1%, against a CPI rate of 3.0% the work force is experiencing a real pay cut. So it isn’t pay that is fuelling inflation, it is the Pound’s sharp devaluation since the Brexit vote. Assuming the Pound remains broadly around current levels, the inflationary impact of the devaluation will eventually drop out.

But because there is much uncertainty about Brexit and what the eventual deal the UK strikes with the EU after she leaves, the Pound very vulnerable to any fresh bad news and the new  inflationary consequences of any further weakness.

The Bank of England Governor’s tone at today’s press conference didn’t sound very much like the Bank is now embarked on a rate hiking cycle like the US Fed. In fact it sounded very much like the move amounted to no more than taking back the emergency 25bp cut the Bank delivered in August 2016 after the “BREXIT” vote to try and support confidence in the economy.

In short, the Bank of England has done no more than clear the air after weeks and months of speculation over when and if a rate hike should indeed be delivered.

Look then, beyond the UK and assess the Euro zone, US and Japanese economies:

   In the Euro zone there is a solid economic recovery taking hold with not just German, but French and the wider Euro zone GDP reports showing solid growth with moderate to low inflation, leading the ECB to moderate the terms of its QE program.
   In the US the Fed has begun to reduce is bloated balance sheet and continues to hike interest rates. Add in the corporation rate tax cut Trump finally looks like getting through Congress and an already solidly growing economy currently zipping along at an annualised rate of 3.0%, looks set to start growing faster yet.
   In Japan. Abe has just been re-elected and will continue to pursue yet more vigorous expansionary policies, aimed at driving up inflation and strengthening growth.

Set against the UK’s anaemic economic performance it isn’t difficult to see Sterling trading much lower. And there is domestic politics: the government has no overall majority, is being rocked by a sex scandal with a hard-left led labour opposition waiting a chance to take power; the mix couldn’t be worse.

In summary, today’s rate hike offered Sterling no support and the other dynamics mention will drive it lower. 

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17th November - Oil, fundamental obstacles in the way of bullish charts

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27th October - This looks like the Dollar breakout

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