The pound gained more than a percent against the US dollar during yesterday’s trading, touching 1.2755 at its highest point and hit a fresh high of 1.1280 against the euro before falling back to 1.1220 on the interbank exchange. Traders are cutting their short positions although the pound is likely to remain under pressure in the short-term and a risk to the downside remains.
Ongoing Brexit negotiations looked set to keep the pound low but a more optimistic tone from Chief Brexit negotiators David Frost and Michel Barnier last Friday has reduced the prospect of no deal, lending some support to the UK currency. That said, the UK is not expected to request an extension to the current transition period, which will mean the UK and EU will need to strike a free trade agreement by late October in order to give the European Parliament time to ratify the deal.
The UK is keen to start face-to-face negotiations with the EU in July and secure an FTA sooner rather than later, but Michel Barnier has pointed towards October as a more realistic date, making the autumn month the make-or-break moment.
Both the UK and EU have stressed their desire to progress trade talks and focus will now turn to top level discussions between Boris Johnson and EU leaders over the coming weeks, as they attempt to break the deadlock.
The UK is still lagging behind Europe in its Covid-19 recovery, which has concerned investors, but key cabinet ministers are keen to get the UK’s engine going again and return the UK to a sense of normality as soon as possible. Many now accept that a “v-shaped” recovery is unlikely and instead it could be more than 18 months before the UK economy returns to pre Covid-19 levels.
Whilst Europe’s bounce back from Covid-19 has been faster than the UK, the economic outlook remains bleak with the ECB recently forecasting an 8.7 percent economic contraction this year with only a 5.2 percent rebound next year.
The ECB recently increased the EU’s Pandemic Emergency Purchase Programme (PEPP) by €600 billion to €1.35 trillion, which will give the ECB firepower until next year and hopefully starve off any individual nation state sovereign debt crisis. However, whilst this increase in quantitative easing is technically necessary, it carries a political risk after the German supreme court recently ruled that the ECB’s bond buying between 2015-2018 was illegal, putting Europe’s largest economy at odds with the ECB.
Whilst the case was ruled against the previous bond buying scheme, the legal arguments stand even more strongly against the ECB’s PEPP expansion. The Bundesbank has stated that it will withdraw from the programme and sell its existing bonds unless the ECB can justify its actions. The ECB has until early August to do this. Given the recent €600 billion increase only received “broad” support from ECB members, a term used described dissent amongst the members, perhaps Lagarde and co, overruling Germany and its northern state allies, this could make for an explosive situation in August.
In the meantime, EU leaders will be focussing on the 7-year budget without the UK’s contribution and the European’s Commission’s €750 billion Covid-19 rescue package, which has yet to be approved by EU leaders and will come into effect next year. Both of which could lead to euro volatility as nation states battle to reach an agreement.
The US dollar has been weakening in the run up to tonight’s Federal Reserve decision as investors weigh up the US’s next move. Federal Reserve Chair Jerome Powell said that the bank crossed “red lines” to support the economy in its time of need, which has led some to believe that the Fed may try to withdraw some of its support. Markets will pay particular attention to the Fed’s monetary policy statement for an insight to future policy.
The dollar also suffered as the National Bureau of Economic Research confirmed on Monday that the US economy has officially entered recession for the first time since 2008-2009 as the Covid-19 crisis forced the country into lockdown. Although, the recession is expected to be deep, many economists predict the recession will be short.
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