It was an excellent start to the year for sterling, which gained ground against the euro in January, although Brexit uncertainty looms, writes Ben Scott of FC Exchange.

Broad-based US dollar weakness meant that January saw the euro reach fresh three-year highs against the buck (EUR/USD), while the GBP/USD currency pair managed to attain its highest level since the Brexit referendum in the region of 1.43 interbank.

However, Brexit had quite a lot of influence over sterling in January and the British currency swung higher and lower as headlines hit the market throughout the month. GBP/EUR traded within a range of around 1.12-1.15 and even attained a seven-month high.

Brexit Back on Track?

The pound enjoyed a rise against the euro at the start of the month (Point A) when UK Prime Minister Theresa May decided to shuffle her Cabinet in the hope of strengthening her Brexit team. Markets saw the move as positive and this allowed the GBP/EUR exchange rate to hit a three-week high.

However, there were still murmurs in the market that the Brexit breakthrough seen before Christmas wasn’t really a breakthrough as it didn’t eliminate much political risk.

As the month continued sterling had another Brexit boost (Point B) after the bill was passed through the House of Commons.

Nevertheless, the bill didn’t stand up well when the Lords Constitution Committee reviewed it, with the Lords stating there would need to be substantial amendments and that it gave too much control to government ministers. When the bill was debated several peers stated that another referendum may need to happen.

Economic Data Surprises to the Upside

By 25th of January the pound had made another surge higher (Point C). It’s arguable that Brexit will be sterling’s main driver in 2018, but January has shown what a dramatic effect the UK’s politics can have on the pound.

Positive market sentiment regarding Brexit buoyed sterling, and better-than-forecast economic data caused the British currency to climb higher. The UK labour market tightened in the three months to November, with unemployment falling by 3,000 to reach 1.44 million. The UK’s unemployment rate has been at a four-decade low at 4.3% for a number of months, although wage growth still lagged behind inflation at 2.4% in November. Inflation has been residing at 3.1%, but January showed a decline to 3.0%.

The strong economic data paired with a more robust labour market encouraged some commentators to suggest the Bank of England’s (BoE) Monetary Policy Committee (MPC) could soon look to increase interest rates once again, following a +0.25% adjustment in November. Economist John Hawksworth commented: ‘'If this pattern of solid jobs growth and a gradual pick-up in earnings growth were to persist through the year, then this could push the MPC towards a further interest rate rise later in 2018.’'

Towards the final few days of the month BoE Governor Mark Carney spoke in the House of Lords, saying that the central bank wasn’t biased towards a Brexit outcome, stating: '‘We don’t have a bias, in terms of the outcome. We look at the economic forces… however the negotiations go… how it affects the exchange rate, how it affects the supply side of the economy, and how it affects demand.’' Carney also said that the likelihood of a ‘disorderly Brexit’ was becoming ‘less likely’ and believes that business investment will receive a boost as the UK gets more clarity on the Brexit process.

When it came to inflation, Carney called time on the retail price index (RPI) which is used as a measure of inflation, as well as the preferred consumer price index (CPI). The RPI is seen as a less reliable and discredited source, and Carney called on the government to stop using it as a guide to dictate student loan interest and rail fare hikes. Carney stated that it would be more prudent to only have a single measure of public-facing inflation.

Draghi and the Euro

European Central Bank (ECB) President Mario Draghi has an interesting relationship with the euro. He’s been nicknamed ‘Super Mario’ after his time as Governor at the Banca d’Italia and his navigation of tricky Italian politics.

Since his time as ECB President he’s been thrown into a difficult situation of trying to preserve the euro amid multiple crises, low inflation, and weak economic growth.

Fast-forward to the present day, and Eurozone growth has been buoyant and inflation seems to finally be showing signs of picking up.

So, when Draghi tries to talk down the euro, it doesn’t really work. In January, the central bank mogul stated that the single currency’s volatility is a ‘source of uncertainty which requires monitoring’. The attempt to quell the currency failed and instead the euro jumped higher, reaching a fresh multi-year high against the US dollar.

It’s not surprising the ECB Chief wanted to jawbone the currency a little as January showed Eurozone inflation had softened to 1.3% (a step further away from the central bank’s 2.0% target), following another decline in December, and the latest reading is the lowest figure since the July last year. Germany also missed its inflation forecasts as the strong euro highlighted the impact it can have.

ING stated: ‘'Even though the Euroboom has continued into 2018, inflation is showing few signs of picking up if 2018 is supposed to be the year of inflation returning, it’s hiding its start pretty well. ‘'

GBP/EUR Forecast

It’s no surprise that markets will be watching Brexit developments for signs of sterling movement, but moving forwards as the UK approaches trade talks (beginning in March) the pound could be particularly volatile. Particularly since Brexit, growth figures have been influential on the pound to see what toll the split from the EU is really having on the British economy; inflation is another ecostats closely watched.

The Eurozone has its own events taking place too, with coalition talks in Germany and shaky politics in Catalonia.

Ben Scott
Foreign Exchange Ltd
www.fcexchange.co.uk