Sterling rally takes a breather while markets await key June ECB meeting
02/Jun/2014 • Currency Updates•
The last days of every month are usually light in macroeconomic and policy news from major currency areas and the end of May was no exception. Major G10 currencies once again traded in very tight ranges, with the exception of sterling. The pound correction from its recent multi-year highs continued last week. Speculative investors’ long positions on the pound had reached extraordinarily high levels and these appear to be in the process of shaking out. In spite of the absence of any negative news for sterling, the currency retreated almost 1% against both the euro and the dollar last week.
Last week we received some negative signs from second-tier macroeconomic reports, as well as comments from Martin Weale, who is staking a position as perhaps the most hawkish member of the MPC. The BBA reported another month of lower mortgage approvals, making in three on a row. Another sign of cooling lending activity came from the Funds for Lending Scheme data, which indicated that in the first quarter credit available to SMEs from banks, had continued to contract. The efforts of the UK Government to encourage bank lending to this critical sector are getting little traction.
These were mildly discouraging reports. However, we note that they come on the heels of almost continuous positive macroeconomic surprises, and see no sign yet to change our positive outlook for the UK economy and sterling. In the short term, however, the extreme long GBP positioning among traders may provide some headwinds for the pound.
A slow week in terms of economic data was dominated by President Draghi’s dovish speech from Portugal on Monday. He stated his concerns about the possibility of a negative deflationary spiral in the Eurozone, and suggested our expectations for the ECB June meeting next week are roughly on target. We expect a 25% cut in the main rate, negative rates in the deposit facility, direct market intervention to improve the flow of credit to SMEs, and the maintenance of long-term refinancing operations (LTRO) for Eurozone banks. At the June meeting we will also get the revised ECB staff forecasts for inflation and growth. We expect a sizable downward revision to both. The shift to a more aggressive easing stance in the ECB contrasts, with the approaching timetable for hikes from both the Federal Reserve and the Bank of England, and we think the euro will struggle to rally in this environment.
The first revision to first-quarter growth numbers came out much worse than expected at -1% QoQ Saar. However, the downward surprise was entirely due to a larger-than-expected drawdown on their inventories by US businesses, and therefore can be expected to be unwound over the next couple of quarters. Nothing in the report changes our view of an economy that was dragged down by severe winter weather and is now bouncing back smartly. The best high-frequency leading indicator in the US, new weekly claims for unemployment benefits, provides support for our view; last week, the number dropped to 300,000, bringing down the four-week average to its lowest level since the 2008-9 crisis at 312,000. In view of the GDP report last week, we are upgrading our expectations for second quarter growth to the 3.5-4% range, and keep our overall 2014 forecast at 2.5%.