US economy

Will sterling hold its gains through the UK general election?


Will sterling hold its gains through the UK general election?

The pound hit a seven-month high last week, rising above $1.30 against the dollar, as investors moved to price in a Conservative victory in Thursday’s general election. A majority for Boris Johnson’s party is seen as the most market-friendly outcome and would probably spark further gains for sterling and shares in domestically focused companies. However, given recent polling suggests a healthy lead for the Tories, the upside could be limited.

A hung parliament remains a possibility and “would likely provoke a very negative reaction from financial markets,” according to David Zahn, head of European fixed income at Franklin Templeton. In the short term, Mr Johnson’s failure to win a majority would probably leave him unable to get his Brexit deal through parliament and would inject renewed uncertainty into the process of leaving the EU.

That could conceivably open the way to a softer, more investor-friendly Brexit than the one negotiated by the prime minister. But getting there would be a complex and highly uncertain process — one reason why the pound has generally rallied recently on strong Tory polling.

A majority for the Labour party looks highly unlikely. Most analysts anticipate a sharp drop in sterling if Jeremy Corbyn pulls off a surprise victory as investors take fright at his promises of massive tax increases and nationalisations.

“The pound would likely fall dramatically and all financial assets would likely decline, reflecting fears the UK economy could head into recession as quickly as the first quarter of 2020,” Mr Zahn said. “Most serious political commentators have ruled out an outright Labour victory, but if we’ve learnt anything in the last three years, it’s ‘be prepared for every eventuality’.” Tommy Stubbington

Will signs of economic growth encourage the ECB to delay a rate cut?

A rate cut was starting to look like a certainty at the European Central Bank’s last rate-setting meeting of the year on Thursday — until data started to show some mild improvement in the struggling eurozone economy.

The trade war between the US and China has dented not just investor sentiment but also the outlook for manufacturing and exports from the eurozone. But after data for November showed that the slowdown in manufacturing in the region was bottoming out, analysts are shifting to the view that the Christine Lagarde-led governing council will refrain from tweaking policy until next year.

“We believe the bar for more easing is high,” said Philippe Gudin, chief Europe economist for Barclays.

German data released on Friday complicates the matter; it transpired that the country’s industrial output had dropped by some 5.3 per cent in October from the same month last year.

Still, George Buckley, an economist at Nomura, expects the ECB to hold off from cutting rates until March owing to broadly better data and persistently low inflation in the region. Barclays’ Mr Gudin takes the view that the central bank will not have to adjust its current -0.5 per cent rate at all throughout 2020 if growth continues to stabilise between 1 per cent and 1.2 per cent.

Mario Draghi, the previous ECB governor, had called for Europe’s governments to “do more” after the central bank launched a fresh package of monetary easing measures in September. This has brought the possibility of fiscal stimulus to the forefront of investors’ minds. Royal Bank of Canada said fiscal policy had become a “buzzword” set to be used even more frequently in the year ahead.

“A gradual recovery in global trade combined with the ongoing support from monetary and to a lesser extent fiscal policies should eventually translate into a stabilisation of economic activity,” Mr Gudin said. Eva Szalay

How long will the Fed pause its rate-cutting cycle?

Federal Reserve policymakers are set to convene in Washington on Wednesday and state their satisfaction with the current stance of monetary policy, on the evidence of strong recent data such as November’s jobs report.

Since October’s meeting, Fed officials have gone to great lengths to prepare market participants for a pause in rate cuts, having lowered the central bank’s benchmark interest rate three times in as many meetings. In mid-November, Fed chairman Jay Powell told US lawmakers that “as long as incoming information about the economy remains broadly consistent with our outlook” there will be little reason to reduce rates further.

Markets have accepted this stance, in the face of robust jobs growth. Futures prices compiled by Bloomberg point to an almost-zero chance that the US central bank proceeds with another quarter-point cut this week. But investors do not see the Fed’s pause persisting throughout 2020. In fact, they are still betting on at least one more rate cut next year.

Much depends on whether the US and China can come to some kind of preliminary trade deal and stave off the implementation of additional tariffs. In October, Mr Powell noted certain risks to the growth outlook — namely, trade developments — had moved “in a positive direction”.

But given US president Donald Trump’s recent admission that he is willing to wait until after next year’s presidential election to strike a limited trade deal with China, the Fed’s hand may be forced again in the not-so-distant future. Colby Smith



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