Markets continued to tread a volatile path yesterday. Sterling in particular succumbed to the volatility and pessimism in the wider market incurring further loses versus the Dollar and notably the Euro yesterday. Despite the decline in Sterling, headline UK stock indices that typically exhibit a strong negative correlation with the Pound failed to catch a bid. Yesterday could therefore have marked the start of something foreboded by now-leadership underdog Rishi Sunak of markets losing confidence in the UK economy.
Due to the significance of the financial sector to the UK economy, there is a mechanism that will arrest the normally negative correlation between Sterling and equities. That is because the causality seemingly only flows one way. All other things equal, a weaker Pound boosts the competitiveness of UK exporting companies overseas and therefore their expected earnings pool. Similarly, it bolsters the UK denominated value of these overseas earnings by making the conversion of profits back into GBP more lucrative. So, it’s easy to see the mechanism by which equities are boosted by Sterling’s woes.
However, in an environment where the equity market is in the driving seat rather than the exchange rate then the correlation can turn positive. When equity market performance is weak in an environment of volatility and uncertainty, there can be a negative feedback loop into GBP. Equity markets in the UK exhibit a far higher correlation with the currency compared with currency areas including the Eurozone and the United States. It will be very difficult therefore for the Pound to recover whilst UK equity market performance remains so lacklustre and in focus.
August has continued to deal a savage blow to the UK Pound with inflation expectations seemingly being ramped up week by week. There is also now a ticking timebomb over the UK and European economies alike in yet another threat to gas provisions from Russia. Yesterday marked the first day of a three-day halt of the Nord Stream 1 pipeline. This has stoked concerns that Russia is looking to continue to leverage the provision of gas as a result of the sanctions imposed against it for its invasion of Ukraine. All eyes are on whether the gas will resume flowing once planned maintenance has been completed.
Discussion and Analysis by Charles Porter
Click Here to Subscribe to the SGM-FX Newsletter
Related Insights
Morning Brief – Opportunity for a weaker Dollar
Charles Porter
Thu 1 Jun 2023
Opportunity for a weaker Dollar The passing of month-end allows markets an opportunity to reassess currency valuations. Despite a cooling off within the Dollar as forecasted following the agreement between the White House and Kevin McCarthy, month end flows yesterday showed favourable conditions for a short-term Dollar resurgence. The beginning of June coincided with headlines […]
Morning Brief – Did EURUSD miss the news?
Charles Porter
Tue 30 May 2023
Did EURUSD miss the news? Over the weekend, the President and the Speaker of the House of Representatives reached a much-awaited deal on the US debt ceiling. The impending constraint on debt could have forced the shutdown of government departments and precluded the US government from servicing costs and existing debts, triggering a default. The […]
Morning Brief – UK Wages
Humphrey Percy
Fri 26 May 2023
UK Wages Bank of England Governor Andrew Bailey yesterday warned of the pressure on wages that are threatening to lead to a wage price spiral as the effects of inflation on the cost of living together with the 12 consecutive interest rate rises that consumers have experienced. The market has not enjoyed the poor inflation […]
