9 Oct 2016

The British Pound can Drag the Euro Down with it

The British Pound (GBP) fell to 31 year lows last week on worries of a hard landing for the UK post Brexit.

author dp
Team INRBonds
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The British Pound (GBP) fell to 31 year lows last week on worries of a hard landing for the UK post Brexit. Euro would have a knock on effect on GBP fall as worries of Brexit effect on the EU mounts.

British Pound pared some of its losses after a precipitous plunge to a fresh 31-year low on Friday and is now at a level of 1.2464 against the USD. The GBP suddenly dived about 10% from levels of around USD 1.2600 to USD 1.1378. The move occurred in a matter of seconds. Market attributes GBP Friday’s sharp decline as a “fat finger” error by a trader or computerised chain reaction, which added to the huge losses which GBP had already suffered during the week amid speculation that Britain is heading for a “hard Brexit”.

The trouble for the GBP started on Monday despite the release of upbeat U.K. manufacturing activity data, which failed to reassure markets over the strength of the economy following the Brexit vote. GBP fell to its three-decade low level against USD and three year low against Euro on Monday. The sentiment for GBP weakened after U.K. Prime Minister Theresa May on Sunday said that she would trigger the process of leaving the European Union by the end of March 2017.

Prime Minister Theresa May, at her Conservative party’s annual conference, said that she was determined to move on with Brexit and win the “right deal” in an effort to ease fears inside her party that she may delay the split with the EU. The statement caught the market by surprise as some were still hoping that Brexit won’t happen.

Triggering Article 50 of the EU’s Lisbon Treaty will give Britain a two-year period to clinch one of the most complex deals in Europe since World War II, and will redefine the country’s ties with its biggest trading partner.

Moreover, the broad strength in the USD has added to the weakness of some major world currencies. USD strengthened after string of upbeat U.S. economic data, which boosted the expectation for a December Fed rate hike and took USD/JPY above 104, EUR/USD below 1.1124 and GBP/USD to its weakest level in more than 3 decades. USD Index (DXY), which tracks the movement of the USD against six major currencies, rose by 1.22% on a week on week basis and is at a level of 96.63. Japanese Yen depreciated by 1.58%, Euro depreciated by 0.30%, GBP depreciated by 4.15% against the USD on weekly basis.

USD is likely to strengthen further in upcoming weeks as the expectation for a rate hike in 2016 is gaining momentum. The Federal Reserve has already made it very clear that how quickly they will raise interest rates hinges on how fast the labour market improves. They are looking for job growth to accelerate, wages to rise and unemployment to either hold steady or improve.

USD started the week on a high note after data released on Monday suggested that the U.S. manufacturing sector grew by more than expected in September, returning into expansion territory, which boosted the optimism over the strength of the economy. Institute for Supply Management reported that its index of manufacturing activity rose to 51.5 in the month of September from August’s reading of 49.4 and against the expectation of an increase to 50.3.

ISM on Wednesday reported that its non-manufacturing purchasing manager’s index rose to an 11-month high of 57.1 in the month of September from 51.4 in August against the expectation for the index to rise to 53.

U.S. payroll processing firm ADP reported that non-farm private employment rose by 154,000 in the month of September against the expectation of an increase of 166,000.

U.S. Department of Labour on Thursday reported that number of individuals filing for initial jobless benefits fell by 5,000 in the week ended 1st October to 249,000 from the previous week’s total of 254,000 against the expectation of a rise of 3,000 to 257,000.

U.S. Labour Department on Friday reported that the economy added 156,000 jobs in the month of September against the expectations for 175,000, followed by 167,000 jobs addition in August. The report also showed that the unemployment rate ticked up to 5.0% last month from 4.9% in August against the expectation of an unchanged reading for September. Average hourly earnings rose 0.2% in September which was largely in line with the expectations, after an uptick of 0.1% in August.

Russian Ruble touched a new high this year as the crude oil prices crosses USD 50 a barrel. Market participants are expecting that OPEC will soon freeze oil output. However, prospects for further rise in oil prices are uncertain. The Brent benchmark crude recently traded over USD 50.50 a barrel after OPEC announced a preliminary deal on freezing production. The members of the cartel agreed on a daily production cut of 700,000 barrels. The deal will be officially presented at a meeting in November.

Further, on Wednesday the U.S. Energy Information Administration reported that domestic crude supplies fell by 3 million barrels in the week ended 30th September against the expectation of 2-million-barrel climb. Russian Ruble appreciated by 0.90% against USD on weekly basis.

Asian currencies were largely down against USD. Australian Dollar depreciated by 1.07%, New Zealand Dollar depreciated by 1.78%, Japanese Yen depreciated by 1.58% against the USD and by 1.27% against the Euro. South Korean Won depreciated by 1.30%, Philippines Peso appreciated by 0.44%, Indonesian Rupiah appreciated by 0.41%, Indian Rupee depreciated by 0.11% against the USD and appreciated by 0.17% against the Euro, Chinese Yuan remained flat, Malaysian Ringgit depreciated by 0.45% and Thai Baht depreciated by 0.86%.