Theresa May not Carney will be key for sterling this week

Last week’s move higher in the pound is of historical significance, sterling had one of its best ever weeks’ on a trade weighted basis. Its 3.7% gain was only matched by a stronger weekly gain in January 2009 when the pound was recovering from the financial crisis. Last week’s move was justified due to the switch to a hawkish stance at the Bank of England, which had largely been unexpected. However, with a 60% chance of a rate hike now priced in for November, the BOE story is getting a bit rich to drive the pound higher for yet another week.

Flip-flopping Carney a threat to the pound

Mark Carney, who did not speak after last Thursday’s meeting, is scheduled to give a lecture to the IMF in Washington this afternoon at 1600 BST, he will then be interviewed by IMF chief Christine Lagarde. Really, what can he say that we don’t know already? If he talks tough on inflation, and suggests to the market that he will be one of the members who could vote for a rate hike at the next meeting then we could see the pound bounce. However, Carney has a habit of flip-flopping when it comes to policy, so the bigger risk could be something dovish from Carney that sets the cat amongst the pigeons and sends the pound lower.

But, if we assume that the market has virtually priced in the prospect of a rate hike in November, then the bigger question now is, is the UK economy strong enough to sustain one rate hike (to reverse last year’s hasty rate cut), or is there going to be a series of hikes like there has been from the US Federal Reserve? Any hints from Carney that the latter is likely then this is bad news for sterling, whereas expectations that a series of hikes are possible could extend the pound’s rally, although we expect any further gains this week to be on the moderate side compared to last week’s pent up explosion of interest in sterling.

Pound bulls put their faith in May

Instead, the next key driver for the pound is likely to be political. Theresa May’s Brexit speech in Florence on Friday is her chance to shift the Brexit debate to a more sterling-friendly tone, it is also the first time we have heard the PM talk about Brexit in a meaningful way since she triggered Article 50 in March. However, she will have to deliver two key points before her speech can be seen as promoting a “soft” Brexit and thus help to boost the pound.

What May needs to do to promote a soft Brexit

Firstly, she must lay out the government’s plan for a healthy transition period that will see the UK remaining in the single market and customs union for a number of years after we leave the EU in March 2019. Secondly, the tone of her speech will be critical. One can expect her to reach out a hand of friendship to get the negotiations onto a more cordial track, her choice of Florence to deliver the speech may be a concession to the Europeans. If May can do this then we could see sterling bounce, but also the FTSE 100 could react. UK banks could benefit as the City of London could cheer a speech that boosts the chance of the UK remaining in the single market after we leave the EU, even if only for a limited period. Big business in the UK, including aerospace, telecoms firms and IT firms could also benefit from remaining in the Customs Union after Brexit. Consumer firms could also benefit from a rising pound, which could help push down import costs and inflation, thus reducing the pressure on the consumer.

Of course, if Theresa May’s speech backfires, especially if she doesn’t lay out in detail her vision for the UK’s position after Brexit, then the speech would be seen as a failure and the pound could be at risk. At this stage, as we wait for May to speak, she holds the power to deliver the catalyst that could take GBP/USD to $1.40.

The technical view

Although GBP is pulling back today against the all major currencies apart from the yen, there is a good argument to be made for a momentum trade for the pound.

• GBP/USD had its best week since the financial crisis, since last week was of less financial significance than 2009, it suggests that there is some deep desire to hold pounds at the moment.
• CFTC data suggests that the market is still short pounds, and the speculative community has some catching up to do, see the chart below, which could boost sterling the coming weeks.
• EUR/GBP also fell below the daily Ichimoku cloud last week, which suggests the euro uptrend could be over for the foreseeable, and GBP could have further room to recover vs. the single currency.

Overall, the pound is in a strong position. We doubt that Carney is going to drive the pound much higher from its current level today unless he confirms that he is on the cusp of voting for a rate hike at the next meeting. Instead, the heavy lifting for the pound is reliant on Theresa May; so if you have faith in the Prime Minister then the pound momentum trade could be here to stay.

Chart 1: 

Source: City Index and Bloomberg