The pound had a good run this year and is ending the year as the second-strongest currency after the euro, so long-term GBP bulls like Pip Diddy are probably grinning from ear to ear right now.
And if you can still remember, the Pound Got A Massive Pounding In 2016, largely because of the Brexit referendum and its negative implications for the U.K. economy and the BOE’s monetary policy, given that many economists were predicting an apocalyptic, Fallout 4 kind of scenario.
This year, however, there were positive developments related to Brexit negotiations and the damage to the U.K. economy wasn’t as horrible as predicted by economists, which is why the pound closed the year on a higher note.
And looking at the COT report, the pound’s rise in 2017 appears to be driven both by short covering and a buildup in pound longs, so much so that large players are now net bullish on GBP. Well, GBP futures at least.
Looking at the pound’s price action, however, we can see that the pound’s rise wasn’t easy and price action on the pound even looks a bit messy.
Price action does look more uniform if we simply exclude GBP/USD, though.
As for specifics, below is a (relatively) quick rundown of major events and an overlay of GBP pairs showing their impact on the pound’s price action.
- The pound started 2017 by taking a dive thanks to Sir Ivan Rogers’ resignation as the British Permanent Representative to the E.U. since his “I quit” letter was leaked and it hinted that Theresa May’s government was so unprepared for a Brexit to the point that they didn’t even have any clear-cut objectives.
- However, the pound later bounced back up on January 17 when Theresa May finally announced her 12 Brexit Objectives while sounding as conciliatory and friendly as can be.
- The tide of battle switched in favor of GBP bears when the BOE announced its February 2 monetary policy decision since the BOE retained its neutral bias despite upgrading their growth and inflation forecasts.
- Disappointment over the BOE’s stance, as well as renewed Brexit-related jitters because of the Brexit Bill, weighed on the pound. However, GBP bulls finally regained their footing on March 15, which is the day before the March BOE statement, wherein the BOE finally switched to a more hawkish stance, with one MPC member (Kristin Forbes) voting for a hike then and there.
- Pound pairs later got a major bullish boost on April 18 when British PM Theresa May called for a snap election to strengthen her political situation and improve her Brexit negotiating positions.
- GBP bears later began to gain the upper hand, however, thanks to the revelation during the May 11 BOE statement that the BOE’s forecasts and hawkish bias were based on the assumption that there will be a “smooth” Brexit transition. BOE Governor Carney even admitted that the BOE didn’t prepare for a “disorderly” Brexit.
- And things only got worse for GBP bulls since the Conservative Party’s lead in the polls began to shrink. And when election day finally came, that culminated in a hung Parliament, causing the pound to plunge across the board.
- Fortunately for GBP bulls, the U.K.’s May period CPI report was better-than-expected, which later convinced two more MPC members to join Forbes in voting for a hike during the June 15 BOE Statement.
- Price action on the pound then became mixed since bulls were encouraged by BOE Chief Economist Andy Haldane’s rather hawkish June 21 speech, which came as a surprise to many since Haldane was a well-known dove. Bears, meanwhile, had Carney’s personal dovish stance and the ongoing battle (at the time) of words between the E.U. and U.K. since the E.U. wants the U.K. to pay up before leaving the Union.
- Another major catalyst that helped GBP bulls was the news that Theresa May was able to hammer out a deal with the Democratic Unionist Party (DUP), which limited the fallout from the elections.
- The bears finally gained the advantage and the pound weakened across all pairs starting on August 3, due to the August BOE statement since the BOE downgraded its growth forecasts while citing “Brexit and related uncertainties,” which implied that the BOE was also getting worried about Brexit, weakening rate hike expectations in the process.
- Pound bulls were finally able to stage a broad-based recovery starting on September 5 when U.K.’s services PMI report for the August period noted that companies were passing on their higher costs, which raised expectations that CPI will continue to rise and force the BOE to hike.
- The pound’s recovery would later evolve into a full-blown rally when the U.K.’s August CPI reading was revealed to have beaten both the market’s expectations and the BOE’s own forecasts.
- That apparently convinced the BOE to sound hawkish again during the September 14 BOE statement.
- And MPC Member Vlieghe’s hawkish hint that the BOE likely won’t stop at one hike was the icing on the cake since Vlieghe has been an outspoken dove until then.
- Unfortunately for GBP bulls, Carney deflated rate hike expectations when he said during his September 18 speech that the BOE is on a tightening cycle because other central banks are also tightening or are expected to.
- And the disappointment doesn’t stop there because rating agency Moody’s announced on September 22 that it downgraded the U.K.’s credit rating from Aa2 to Aa1 and its outlook from “stable” to “negative” largely because of Brexit-related uncertainty.
- Theresa May’s October 4 speech at the Conservative Party Conference was also a source of pain for the pound since her speech was viewed as having eroded her leadership rather than reinforce it, market analysts say.
- The pound finally found support on most pairs on October 5, thanks to two positive developments. The first was the news that Theresa May plans to reshuffle her cabinet to have firmer control in government while the second was the revelation that the Office for National Statistics (ONS) made a mistake in its calculations which resulted in revisions to its labour productivity report. The upgraded labor costs, in particular, was cited by market analysts as the reason for the pound’s strength since that raised odds for a November BOE rate hike.
- The pound kept rising on most pairs after that. But when the November BOE statement finally came, the pound tanked even though the BOE delivered on a rate hike, likely because the BOE hinted that further hikes were unlikely. Fortunately for pound bulls, the BOE still maintained its hiking bias. Moreover, economic reports released after the November BOE statement were mostly positive.
- Focus shifted away from monetary policy and back to Brexit during the months of November and December. And all the drama culminated in a successful deal to move Brexit talks on to Phase 2, which refers to the transition period and a post-Brexit trade deal. Instead of jumping higher, however, the pound encountered selling pressure, likely because E.U. officials were quick to warn that the next stage of talks will be even more difficult. And that’s where we stand today.
The drivers for the pound’s price action can be categorized into either (1) Brexit-related stuff or (2) stuff related to monetary policy.
Economic data also had an impact, but they were mostly viewed within the framework of monetary policy, which is why CPI reports and the wage growth component of the jobs report tend to be the most market-moving economic data.
Anyhow, Brexit talks are will be moving to Phase 2 in 2018 so Brexit-related developments will almost certainly continue to have an impact on the pound’s price action.
Heck, it can even be argued that Phase 2 talks will likely have a bigger impact since Phase 2 talks will define the U.K.’s post-Brexit trading relationship with the E.U. So if negotiations don’t too well, then that would likely be bad news for the pound. But on the flip side, if negotiations are relatively smooth and rhetoric remain somewhat conciliatory, then the pound’s recovery will likely continue.
Economic data and BOE rate hike expectations will also likely continue to have a role to play. Presently, rate hike expectations have been pushed into the background because the BOE said during the December BOE statement that:
“[I]t is too early to arrive at a comprehensive view of the effect of November’s rise in Bank Rate on the economy.”
Moreover, the BOE said that:
“The MPC continued to judge that inflation was likely to be close to its peak, and would decline towards the 2% target in the medium term.”
In other words, the BOE thinks that the current monetary policy is sufficient to keep inflation in check until the temporary inflationary pressure from the pound’s post-Brexit referendum slump finally abates. And that means that if inflation remains elevated, or worse, strengthens further, then the BOE may be forced to hike rates again, which will put monetary policy under the spotlight once more, especially since real wage growth has been negative.
What do you think? Will the pound’s recovery continue and become a long-term rally? Or will the pound resume its post-Brexit referendum slide, especially if Brexit talks don’t go too well?