Tories prove toxic for the pound as Tesco wobbles on good news
City Index October 4, 2017 5:00 AM
The pound has fallen more than 1% so far this week, is this just a coincidence that it coincides with the Tory Party conference? Last year May pushed the pound down some 6% when she touted the prospect of “hard Brexit” during her keynote speech
The pound has fallen more than 1% so far this week, is this just a coincidence that it coincides with the Tory Party conference? Last year May pushed the pound down some 6% when she touted the prospect of “hard Brexit” during her keynote speech. This year’s reaction has been milder, and the pound is riding a bid this morning as UK services sector PMI beat expectations.
Politics still chief driver of sterling
There can be no doubting that politics is still a big driver of the pound right now. We believe it is the reason that the pound has fallen on a broad basis this week, and it is one of the weakest performers in the G10, only slightly above the NZD and USD. The pound is also defying decent economic data, has been falling even though Citi’s UK economic surprise index has been rising, suggesting that economic data is outperforming expectations, which tends to be good news for a currency. The pound also has yield support, 10-year Gilt yields remain close to their highest level since February, and there is now a 77% chance of a rate hike in November.
Pound: the wallflower of the FX world
All of these factors should be pound positive, however, the one factor that outweighs all others for sterling is politics. With little progress on Brexit even after May’s Florence speech, continued cabinetry infighting and the prospect of May once again using her Conference speech, due later today, to placate Brexit hardliners, the market is sitting on the side-lines. Overall, sterling may struggle to extend gains much past $1.36, the recent high, for the rest of this year.
This doesn’t mean that we expect GBP to fall off a cliff; instead we expect a range between $1.30 and $1.35/36 to persist for some time. The reasons to buy the pound are few and far between, however, they do include the slight shift to a less dovish stance from the BOE. As mentioned above, they are expected to hike in November, although even when accounting for this rate hike, rates are still likely to remain low for some time. Also, the dollar rally seems to be losing steam as the market starts to fret about the next Fed governor and the prospect of a dovish chief at the helm of the US central bank once Janet Yellen’s term ends early next year. This may also benefit the pound, however, we still think it remains a fairly lacklustre option for investors trading G10 FX. The latest positioning data, that shows long GBP positions entering positive territory for the first time in 2 years could be used as a contrarian indicator and a reason to sell rallies in GBP for the short term.
Why the pound’s fortunes rests with May
All of this leads us to be cautious about GBP as we lead up to May’s speech. GBPUSD has risen some 35 pips on the back of this morning’s PMI surprise, but even this seems restrained given it is by far the largest sector of our economy. May can limit another fallout from her speech by concentrating on domestic issues, she is likely to announce a plan to build council houses and cap university tuition fees. What we don’t know is how she will frame her position on Brexit, anything that sounds too much like a hard Brexit could send the pound tumbling, with Tuesday’s low at 1.3222 a key short term support. Overall, we have little faith that the pound will react well to May’s speech and GBP bulls should be cautious.
Why good news is bad news for Tesco
Tesco is the key news story in the FTSE 100 today, but not even news that it is reinstating its dividend could boost the share price, which has fallen more than 4% so far on Wednesday. Sometimes good news is sold in equity markets, and that seems to be the case here, especially since the share price had reached a 3-month high leading up to the results. Also, some analysts are starting to worry that even solid like-for-like sales growth (3% when stripping out property profits) aren’t enough to cover rising fixed costs like wages. Tesco did see some of its profit gain come from sales of commercial property; this is a one off gain, so if sales can’t keep pace in the second half of this year, profit growth may only be illusory. Unfortunately for Tesco, Aldi and Lidl are still in business, and even if Amazon’s foray into food sales has so far failed to take off, analysts are always going to fret about Tesco’s sales potential with these two formidable competitors.
Ahead today, Theresa May’s speech is critical for the pound, while US economic data could boost the dollar. US equity futures point to a slightly weaker open for US markets, after a strong couple of days.