The following article was written by Jasper Lawler, Senior Market Analyst at FCA regulated broker LCG.
Jasper Lawler
After extending gains for a second consecutive week last week, the pound continues to hover around a six-week high versus the dollar. Last week a softening of tone from Brussels over Brexit talks and signs that the EU are willing to make some concessions to the UK to avoid a no deal Brexit helped boost sterling. Upbeat economic data also contributed to the pound’s rally, with earnings data and GDP surprising to the upside.
The coming two days could see volatility return to the pound. Brexit talks are expected to step up a gear at an informal EU gathering in Salzburg, Austria, on Thursday, September 20, whilst CPI data on Wednesday will also be watched closely.
CPI to tick lower?
Inflation could act as a drag on the pound, with expectations of CPI to tick lower in August to 2.4%, down from 2.5% in July, as it moves towards the BoE’s target of 2%. Meanwhile core inflation which strips out more volatile items such as food and fuel, is expected to fall to 1.8% in August, down from 1.9% the previous month.
The BoE raised interest rates in August and the market is not convincingly pricing in another hike from the central bank until the end of next year. So, whilst a tick lower in inflation will be good news for the struggling consumer, as it keeps earnings above inflation, it will reduce the odds of an interest rate rise, which we expect to pull the pound lower. On the other hand, an unexpected lift in inflation could see the pound look to retake $1.3170 the recent six week high.
Will Salzburg talks send the pound back beloe $1.30?
The pound’s reaction to the CPI reading could be short lived as attention will quickly switch to the EU Salzburg summit in Austria. This will be the first time that the EU leaders have met since Theresa May’s now infamous Chequers Brexit plan. So, with the deadline looming closer will we finally see some serious progress towards a Brexit deal? With the pound’s sensitivity to any Brexit headlines these talks could be key for deciding whether the pound will remain above $1.30 in the near term.
Whilst there have been signs that the EU are softening their position towards the UK over Brexit, this is more atmospherically rather than a serious fundamental shift. The EU have seen the political turmoil in the UK and want to help struggling Theresa May secure a Brexit deal. However, for the EU, a Brexit deal can not come at the price of compromising the EU itself. Therefore, there are some key principals which they are not willing to compromise on. Furthermore, Theresa May is refusing to budge on her red lines and we are getting to the point where the can can’t be kicked much further down the road, particularly regarding the Irish border issue.
Whilst her European peers are not allowed to negotiate with her, this rests with the European Commission, Theresa May will give a speech on Wednesday evening, which is being seen as a good opportunity for the PM to lay out what she needs from the EU in order to get a deal through.
However, given huge domestic political pressures on Theresa May, the reality is that she will probably have little to say until after the Conservative Party Conference in October. Therefore, there is a serious risk that pound traders will be disappointed by the talks. Continued deadlock over the Irish border and nothing noteworthy from Theresa May, could see pound traders lose faith over recent positive developments and send the pound back below $1.30.
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