Morning Brief – Top Trumps

Top Trumps

As eagle eyed purveyors of the foreign exchange market I’m sure each of you reading this would have been keeping a watchful eye over the actions of the Federal Reserve Bank in the United States and UK inflation yesterday. In fact, both events seem like they might go down as the two most important events of 2019 not to have (yet) moved the foreign exchange market. 

UK Inflation

Since the referendum in 2016 wiped out up to 15% of the value of the Pound versus its major peers, inflation has held firm. As a consequence of the United Kingdom importing a high proportion of its consumables and goods in from abroad, the weaker Pound immediately pushed import prices higher, raising the general price level. Due to the economic rule that higher inflation rates are normally signalling stronger economic activity, the Bank of England was able to perform a juggling act presenting above-target inflation as a symptom of a robust domestic economy, not a struggling one.

The three years since the referendum have therefore seen the Bank of England play an accidental role as the defender of the value of the Pound. Whilst politics and global economics might not have been on its side, the role of our central bank in promising higher yields behind the Pound when the rest of the world’s central banks were easing policies saw it claw back and protect the value of GBP. However, the truth behind domestic inflation, particularly within more homeward orientated markets that seldom compete overseas, has been one of relative stagnation. Within importation markets we always see lags whilst reserves are depleted and statistics sort themselves out. Across the world, for example, we measure inflation in year-on-year terms so the observed inflation rate is the price change versus twelve months ago.

A systemically higher inflation rate caused by rapidly inflating import prices is gradually eroded by this year-on-year observation method; higher prices today compared with similarly high prices one year ago in percentage change terms do not show up. Yesterday’s inflation reading of only 1.7%, the lowest since 2016, will worry markets that inflation will continue to fall now that the statistical obscurity has worn out. All this means that the Bank of England, through its use of sanguine language, may not be able to be the defender of the value of the Pound, opening the path for it to move lower if political (read Brexit) developments do not play out in its favour. Yesterday the Pound fell but only minutely reflecting investors’ preoccupation with Brexit and all things politics.

Today the Bank of England will deliver its September policy decision. They are unlikely to follow the US in cutting rates given the one off nature of this data, however, their language will be studied to gauge expectation surrounding future price movements. 

FED

The Federal Reserve Bank in the United States cut interest rates but 25 basis points, 0.25%, yesterday evening. With the president’s scathing reaction to the decision, the broadcast of the Fed meeting could rather have been on Comedy Central under the programming of “The Roast of Jay Powell”. But there’s always a certain joy in watching a central banker explain that all is rosy, couldn’t be better, but we’ve got to cut interest rates once again in a consecutive meeting. 

A hawkish press meeting following the cut decision pushed the US Dollar higher but only marginally, keeping USD within its week-to-date range. The limited price action reflects investors’ distrust in the banking authority but also their distaste to enter alternative currencies and assets – it’s still the best of a bad bunch. However, with the lion’s share of foreign exchange traded in the City of London, more US Dollars are traded in London than in New York. My suspicion is that traders in Europe are unlikely to be impressed by last night’s decision and so steer on the side of caution with respect to Dollar holdings. 

Discussion and Analysis by Charles Porter

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