US tax-reforms are imminent. UK wage growth is picking up. The UK consumer outlook is clouded. Barnier puts end-date on transition and softens on trade.
The Pound edged higher against the Dollar but fell sharply against the Euro ahead of the London close Wednesday, after struggling to draw a meaningful boost from recent developments in the economy and Brexit negotiations.
Wednesday’s price action comes ahead of a crucial vote on US tax reforms, scheduled for the evening hours London time, which will be followed by a speech from President Trump.
The Senate approved the joint tax bill Tuesday by a margin of 51-48, leaving just the House of Representatives outstanding.
Most strategists see the tax bill’s implications for the Dollar as muted over the broader term, while its likely impact on the US economy is also uncertain, but that won't preclude the greenback from a strong finish to the year after the bill emerges from the other end of the congressional gauntlet.
For now, the US currency remains on the back foot ahead of the House vote which, essential if the reforms are to be enacted in the New Year, is helping to support the Pound-to-Dollar rate.
Sterling was quoted 0.17% higher at 1.3409 against the Dollar. The Pound-to-Euro rate was marked 0.22% lower at 1.1284 while the Euro-to-Dollar rate was quoted 0.39% higher at 1.1846.
The Euro-Dollar rate outperformed the Pound-Dollar pair over the course of Tuesday, leading to a slump in the Pound-to-Euro rate, which is a trend that continued Wednesday.
Markets can set Pound-to-Euro prices independently of other rates but, as a foreign exchange cross-rate, GBP/EUR is at heart the product of a simple equation that divides GBP/USD over the EUR/USD price.
These are the underlying mechanics of the market and so, when the prices set by independent order books deviate away from the output of the above equation, any discrepancy is quickly arbitraged away.
Above: Pound-to-Euro rate shown at hourly intervals.
Wages and Bank of England in Focus
After many months of anticipation, last week’s decision by the European Council to allow its negotiators to begin discussing future trade ties with the UK proved something of an anticlimax for the Pound.
Sterling has since traded marginally below its early-December levels relative to the Euro and Dollar but this might all change in the New Year, if analyst commentary around the latest Office for National Statistics wage data is to be believed.
ONS data showed Tuesday that wage costs per hour rose by 2.5% during the three months to the end of September, up from 1.3% in the second quarter, while whole economy labour costs increased at a rate of 3%.
Whole economy labour costs include changes in wages and salaries, but also benefits in kind and employer contributions to things like pensions, sickness and maternity pay.
“This admittedly is not yet alarming from a historic perspective – this measure of wage growth was higher for a period of five consecutive quarters in 2015-16 but the jump is certainly consistent with other measures showing a pick-up in wage growth,” says Derek Halpenny, European head of global markets research at MUFG.
Headline consumer price inflation is currently at 3.1% and expected to fall progressively throughout 2018. Should wage packets continue to grow at their current pace, while inflation falls, the “real incomes” squeeze that has pressured the economy since the Brexit vote in June 2016 might soon begin to dissipate.
“So nothing for the MPC to get alarmed with right now but continued evidence like this in Q1 next year will force the BoE into an earlier than expected tightening of monetary policy. We expect the next hike in May,” says Halpenny.
The Bank of England raised its interest rate by 25 basis points in November, taking it to 0.50%, but fixed income and interest rate derivatives pricing suggests the market is expects only one further interest rate rise per year until the end of 2020.
“We have a bullish GBP view in part based on our belief that the MPC will have to raise rates twice next year – the market is barely priced for one increase. Domestically generated inflation pressures are building and that is unlikely to be ignored by the MPC for long,” Halpenny adds.
Separately, and also on Wednesday, Bank of England governor Mark Carney will testify before the Treasury Select Committee. The testimony will focus on the November financial stability report produced by the bank but, by definition, there is scope for the discussion among MPs and the governor to veer onto the subject of Brexit.
Barnier Puts End Date on Transition, Softens on Trade
European Commission negotiator Michel Barnier laid out the Commission’s draft guidelines for the next phase of Brexit negotiations Wednesday, building on those issued by the European Council Friday.
Much of the draft statement was a reiteration of the details given by the Council Friday but Barnier did say that any “transition” period would need to come to and end on December 31 2020, at the same time as the current European Union budget comes to an end.
The statements also cast fresh light over the scope for deadlock in talks to emerge once into the New Year, with Brussels insisting that the future relationship can only be agreed in outline before the UK enters transition, with the bulk of a final deal to be struck after March 2019.
The withdrawal agreement, entitling the EU to substantial payments and bestowing various other obligations on the UK, must be legislated for ahead of the UK’s departure. Bariner also threw down another hurdle to the UK government.
“Legally speaking, mechanically, the day after the U.K. has left the EU institutions, the U.K. will no longer be covered by our international agreements,” he said at a press conference. “They will be leaving approximately 750 agreements, which we have signed.”
If proven to be correct then this, combined with third country status in transition, could become a stumbling block for the government if it folds on its earlier demand the UK be able to strike trade deals while in “transition”.
Any constraint on being able to enter into deals before the transition ends could mean the UK is unable to renew and therefore, temporarily excluded from, the existing trade agreements the EU has with other countries.
That said, the documents released Wednesday bore signs of a possible softening in Brussels stance on this point.
“Where it is in the interest of the Union, the Union may consider whether and how arrangements can be agreed that would maintain the effects of the agreements as regards the United Kingdom during the transition period,” the draft documents say.
Consumer Outlook Clouds into Year-end
The discussion around retailers and the economy is noisy and the outlook clouded going into year end, with conflicting signals coming from various indicators of consumer spending in recent weeks.
Office for National Statistics data showed consumer spending rising by 1.1% in November, when compared with the month before, while annual growth was close to 2%.
These numbers were far ahead of the consensus for more muted month-on-month growth of 0.4%, and largely the result of Black Friday promotions.
However, economists are now suggesting consumer spending might moderate a touch during December, which is an idea that was supported Wednesday by the latest Confederation of British Industry Distributive Trades survey.
“Retail sales volumes saw a second month of growth in the year to December, but this disappointed expectations of stronger growth. Sales are expected to rise at a similar pace in the year to January,” the CBI wrote in its report Wednesday.
The Distributive Trades survey polls 109 firms, 56 of which are retailers, who account for more than a third of all employment in the retail sector. It asks firms to state whether sales have risen or fallen and how actual results have compared with expectations.
“37% of retailers said that sales volumes were up in December on a year ago, whilst 17% said they were down, giving a balance of +20%. Growth was slower than expected (+30%), and slightly slower than in November (+26%),” the CBI said Wednesday.
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