by Marc Chandler
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Summary:
Sterling’s recovery began before today and went through technical levels that accelerated the advance.
The interest rate market did not change sufficiently to indicate a change in policy expectations.
The High Court decision will be appealed.
Sterling is the strongest currency today. The 1.3% gain (at $1.2460) edges out the Mexican peso (1.2%). It is the biggest advance in three months.
The precise cause of the rally is debatable. Some link it to the High Court decision that the UK Parliament has the right to vote on Brexit before Article 50 is triggered. Parliament is thought to be less sympathetic, and its involvement is understood by many to reduce the chances of a hard exit, under which the UK would lose access to the single market.
Yet, as was widely anticipated, the government quickly announced it would appeal the ruling to the Supreme Court, which had been prepared for this. A judgment is expected next month. The decision also sparked speculation that Prime Minister May would call snap elections. The Tories have a small majority, and it may not be sufficient to overturn or make an end run around the legislation that established a fixed election cycle. May has previously indicated no desire to try to maneuver such a way. Today, her spokesperson reiterated this position, despite the fact that Labour appears to be poorly prepared to challenge her.
There was also the BOE meeting and the Quarterly Inflation Report. The MPC was more hawkish than expected. The central bank increased next year’s forecast for growth and inflation (2.7% CPI from 2.0% and 1.4% GDP from 0.8%). The central bank adopted a more neutral setting, with Carney explicitly indicating there were limits to his tolerance for inflation overshoot and that policy can respond to either direction the economy moves.
Some try to link sterling’s strength to the prospect of the BOE lifting rates, but the interest rate market does not show this. The implied yield of the June 2017 short sterling (three-month deposit) rose a single basis point to 44 bp today. It finished last week at 45 bp and the week below at 41 bp. The 10-year Gilt yield rose three bp, within a half a basis point of the German increase today. Over the past five sessions, the UK yield is off five bp compared with a little more than one in Germany and four in the US.
An alternative explanation recognizes that corrective forces were evident before today, and today’s gain took out levels and likely spurred short-covering. As we have noted in our review of positioning in the futures market, the gross longs have been increasing for a few weeks as bottom pickers emerge. However, the gross shorts have barely covered and remained near record levels. Today is the fifth consecutive session of sterling gains and the seventh advance in nine sessions.
Our reading of technical indicators warn the upside correction many notes is over. A break above $1.25 could spur a move toward $1.2620-$1.2640. There is a trendline on the hourly bar charts drawn off yesterday’s lows and catching today’s. It will come in around $1.24 by the European morning tomorrow.
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