EUR is FX king as UK growth woes continue to weigh on pound

The euro is the undisputed FX king in the G10 space this morning. It is the top performer so far this week, and it was given another push higher after decent GDP data for Q3.

The euro is the undisputed FX king in the G10 space this morning. It is the top performer so far this week, and it was given another push higher after decent GDP data for Q3. Interestingly, Germany and Italy, two ends of the Eurozone growth spectrum, managed to post above-consensus growth figures for the three months ending in September, with German GDP rising by a decent 2.8% and Italian GDP rising by an equally impressive 1.8%, above the UK’s paltry rate of 1.5% for last quarter.

Decent growth fundamentals are the perfect tonic for the euro at the moment. The single currency has capitalised on its economic strength alongside its political stability while the pound languishes in a Kafka-esque Brexit nightmare and the US dollar gets stalled by concerns about tax reform. This could be the euro’s moment to shine, and it is why we believe that we could see back to the $1.1860 highs in EUR/USD before a potential re-run of $1.20 before year end.

Why UK growth malaise can’t all be blamed on Brexit

Chart 1 below shows the sorry state of the UK’s growth rate, lagging behind all of the other major G7 economies. This was not the case at the end of 2014, when the UK was leading the way in the growth stakes. Interestingly, the UK’s growth rate relative to its peers (the chart has been normalised to show how countries’ grow relative to each other), has been slipping since 2015, so even for staunch remainers’ like me, we can’t blame all of the UK’s economic slowdown on the Brexit vote. Perhaps this is why the pound hasn’t fallen off a cliff so far this week, even though it did take a battering on Monday, as political pressures and Brexit deadlines start to mount.

Wages and sterling: the link explained

The inflation data could have been worse for the UK, prices remain at 3% for the second month in a row. This also weighed on the pound this morning, however, GBP/USD remains above Monday’s low of $1.3062 and is still above the key $1.3040 support level. For now we remain cautiously optimistic to the prospect of a rebound for the pound, especially if we see decent labour market data tomorrow and better than expected retail sales on Thursday. However, the pound’s prospects are limited, and today’s inflation data has only reinforced the major headwind for the UK economy: a hobbled consumer. Real wages, if they come in line with expectations on Wednesday are likely to be -0.9%, so consumers have less to spend as the crucial holiday season sets in. Interestingly, as you can see in chart 2, there is a positive correlation with real wage growth and the pound over the long term, and the pound has fallen at the same time as wages have remained stagnant. This is partly because a weak pound pushes up inflation and thus pushes down real wages, but it could also be symbolic of the pockets of weakness in the UK’s growth story which makes the pound a less attractive FX option for investors’ right now.  

Why the Dax is vulnerable

In conclusion, the future of the pound and whether it crashes below the key $1.3040 level could be dependent on tomorrow and Thursday’s data releases. From an equity perspective, the weaker pound is once again helping the FTSE 100 to outpace its European counterparts, whole the Dax is just about in positive territory after Monday’s sharp sell-off. 13,000 is a key support level for the Dax index, it continues to remain vulnerable to a drop below this level and potentially back to 12,580 – the 100-day sma. Further Dax losses could come quicker than expected if we continue to see the euro outperform, as we expect. Thus, it could be a bumpy ride to the end of the year for the German index.

Chart 1

Source: Bloomberg and City Index

Chart 2:

Source: Bloomberg and City Index 

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