People were urged to ‘stay out of the sun’ by the Met Office as a level 3  weather warning was issued on Friday. I, like many, ignored the “experts” and took full advantage of the warm weather and basked in the sun, once again without sun cream.
Though my face avoided getting burnt (again), emerging markets dipped slightly into the red as risk-assets lacked direction. Asset class returns in sterling and local currency are below; though markets were flat last week, the cushioning effect from a fall in the pound prevented sterling investors from disappointment.
Table 1: GBP total returns
Table 2: Local CCY total returns
Speculation as to whether the Bank of England (BoE) will raise interest rates in the UK has been rife of late. Though partially offset by positive news flow around negotiations for the UK’s withdrawal from the European Union, last week saw a rollercoaster ride for traders arising from a string of disappointing data releases that cast doubt over the possibility of an August rate rise. Thus sterling finished the week circa 0.75% lower against the dollar, having weakened by as much as 2% intra-month.
An initial gain for sterling on Monday was precipitated by the UK Government conceding crucial amendments before a Parliamentary vote tabled by the influential pro-Brexit group, the European Research Group (ERG). This reduced the risk of a Government defeat, heightened following the so-called Chequers compromise which resulted in the resignation of several key Cabinet ministers (including the Brexit Secretary David Davis and Foreign Secretary Boris Johnson).
Monday also saw the defeat of an amendment, backed by the opposition, to keep the UK within the EU’s Custom Union should a no-deal scenario occur. While currency markets remained firm, the defeat of such a “backstop” proposal is significant, leaving the Government’s negotiating hand unrestricted as it moves towards the final stages. The pound does however remain sensitive to ongoing discussions, which was again highlighted on Friday when the EU’s Chief Negotiator Michel Barnier said the EU is open to amending the current proposal on the Irish border.
Chart 1: Sensitivity of the last week’s events and data releases on the British pound relative to the US dollar
Widely anticipated data releases sought to mute the short-lived gains following the Brexit-related developments throughout last week; while Tuesday’s unemployment rate remained at a multi-decade low, average weekly earnings growth slowed from the previous month muting expectations around future inflation. This was confirmed on Wednesday with a softer than expected inflation reading, largely attributable to declining prices for clothing and footwear. These downward cost pressures amounted to the latest evidence of the so called “Amazon effect”, whereby retailers are forced to eat into their margins by discounting products aggressively in order to attract consumers away from online marketplaces. An ONS release on Friday evidences the failure of the high street retailers in customer retention, as online clothing and footwear stores achieved new UK record proportions for the fourth consecutive month. The UK appears especially prone to these effects, due to the extent of online retail versus international peers (see Stat of the Week).
Chart 2: Muted year-on-year increases in Clothing and Footwear prices have broadly fallen below the main inflation figure, reflecting the disinflationary “Amazon effect”
Source: Bloomberg, UK Office for National Statistics (ONS)
The increasingly split Monetary Policy Committee makes second guessing the August interest rate decision difficult, despite such a high probability of a rise being implied by the market. Policy makers are sure to be cautious about acting too aggressively for fear of damaging the UK’s growth prospects, though simultaneously they will be cognisant that disappointing the market will have negative consequences.
THE WEEK AHEAD
Monday: Eurozone Consumer Confidence, US Existing Home Sales
Tuesday: Germany Markit Manufacturing PMI
Wednesday: Germany Ifo Business Climate, US New Home Sales
Thursday: South Korea GDP Q2, Germany Gfk Consumer Confidence, ECB Interest Rate Decision, US Durable Goods Orders
Friday: France GDP Q2, US GDP Q2
STAT OF THE WEEK: 17.4% and 9.5% – the proportion of total retail sales made up by online transactions in the UK and US respectively (ONS, US Census Bureau).
Data correct as at 20/07/18