Dollar drifts higher as geopolitical concerns mount

Claire Hogarth21/Jul/2014Currency Updates

Last week brought investors’ focus squarely back to geopolitical issues. The downing of a passenger jet over rebel-held territory in the Ukraine, and the escalation of the Israeli attack on Gaza dominated the headlines. As one would expect, political uncertainty buoyed the dollar, which ended the week moderately up against both sterling and the euro. Among risk assets, equities took the skittishness relatively well, but credit spreads and European peripheral bonds suffered, weighted down by the lack of positive headlines on the troubles of Portuguese lender Banco Espiritu Santo.

GBP

A surprising spike in both headline and core inflation was the main news last week in the UK. Headline inflation rose from 1.5% to 1.9% YoY, and core inflation rose even more, from 1.6% to 2.0%. Transport services and clothing and footwear inflation accounted for most of this jump. We think these surprises have mostly to do with seasonal discounting patterns, and expect them to be reversed over the summer months.

The labour market continued to give mixed signals. The unemployment rate in the three months to May dropped again, to 6.5%, but the absence of any pay growth became even more pronounced, as average weekly earnings slowed from 0.8% YoY to 0.3% YoY. Real pay is therefore continuing to shrink, a development that supports our call that the most likely timetable for the first hike from the Bank of England will not come until the first quarter of 2015.

EUR

Economic data out of the Eurozone last week was mostly weak. Industrial production fell 1.1% on the month in May, confirming the weakness we had seen in the national reports. Again, we are seeing a gap develop between the relatively optimistic manufacturing PMI index and actual production data, a pattern that we have been pointing to for some time. The German ZEW index of investors sentiment, which tends to lead developments in the German PMI, softened somewhat. However, both the ZEW and industrial production belong in the second-tier category, and all eyes now turn to the more important PMI indices to be released next week. We expect them to be consistent with sluggish growth of around 1%. This insufficient rate, together with deflationary pressures, means that there is a non-zero chance that the ECB will announce further aggressive measures at its September meeting.

USD

June economic reports were mixed. On the one hand, core retail sales in June rose a solid 0.6% on the month, leaving the trend clearly above the 4% annualised level. Very strong July surveys from the manufacturing sector contrasted with nearly flat factory industrial production in June. The housing sector continues to send conflicting signals, as very strong home sales contrasted with a 9.3% decline in housing starts. None of these second-tier reports change our view, supported by recent labour market strength, of a US economy bouncing back strongly from a weather-induced first quarter decline.

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Written by Claire Hogarth

Marketing Executive at Ebury. English Literature graduate from the University of York and a motivated professional.