Sterling bounces on 'BREMAIN' sentiment...

Week Commencing Monday 23rd May 2016

Overriding Market Themes

The US is on the verge of meeting most of the economic conditions the Federal Reserve has set to increase interest rates next month. Eric Rosengren, who is the president of the Federal Reserve Bank of Boston, said to the press he was getting ready to back tighter monetary policy after financial and economic indicators swung in a positive direction after the Fed’s policy meeting in March. The minutes of the March meeting suggest that the FOMC could be ready to move on policy again much sooner than anticipated, after increasing rates by a quarter of a percentage point at the end of last year. The bank has kept interest rates between 0.25 percent and 0.5 percent since December.

Moving to Japan now, Japan's economy expanded at the fastest pace in a year in the first quarter, thanks in part to a leap year consumption boost, but analysts say the rebound is not strong enough to dispel concerns over a contraction this quarter. The world's third-largest economy expanded by an annualized 1.7 percent in January-March, much more than a median market forecast for a 0.2 percent increase and rebounding from a 1.7 percent contraction in the previous quarter. Analysts had worried that the January-March period would not produce enough growth to avert recession - defined as two straight quarters of contraction - after stripping out the estimated boost from the leap year. Private consumption, which makes up 60 percent of GDP, rose 0.5 percent, more than double the median market forecast, as households boosted spending on televisions, food and beverage, and recreation, the data showed. But the rebound failed to make up for a 0.8 percent drop the previous quarter. Japan's economy contracted in the final quarter of last year as slow wage growth hurt private consumption, while exports felt the pinch from sluggish emerging market demand and the pain of a strong yen.

Finally, the UK could sink into a year long recession if it votes to leave the European Union, Chancellor of the Exchequer George Osborne said in his latest attempt to focus voters on the potential hit to the economy from an "Out" vote. The new analysis by the treasury of the referendum's short-term implications for economy set out two post-Brexit scenarios. A milder 'shock' scenario, based on Britain reaching a trade deal with the EU, would result in the economy being 3.6 percent lower after two years than it would be if Britain stayed in the EU, the ministry said. Inflation would rise and house prices would be 10 percent lower than under an "In" vote. The economy would suffer a more severe shock if Britain left the EU's single market, as suggested by some leading "Out" campaigners, and defaulted to World Trade Organisation rules, which would raise barriers to trade. Under that scenario, the economy would be 6 percent smaller within two years than if Britain voted to stay in the EU, inflation would rise more sharply and house prices would be 18 percent lower, the report said. The rival “Out” campaign have dismissed the new analysis as politically motivated and argue that the potential benefits outweigh the risks. With the referendum getting painfully close, expect more of the same from both sides as they attempt to woe the large undecided contingent of voters to their respective causes.

 

GBP This Week

A light week ahead for the UK with the second estimate of Q1 GDP will likely reconfirm the 0.4 percent print we saw in the preliminary. We also await the expenditure breakdown, with the report likely to show a small slowdown in household consumption.

The referendum continues to dominate financial markets, with average bookmaker odds for a “Brexit” being slashed to 22 percent from 28 percent a week ago. The improved sentiment has supported a 2.5 percent rally in the trade-weighted GBP over the past week, and this trend should continue if we see further polling consistent with the above.

USD This Week

In terms of data releases this week, we look forward to Thursday’s pending home sales, durable goods, the second print of GDP and the University of Michigan consumer index. We look for pending home sales to have increased by 0.8 percent in April. We expect the second estimate of Q1 GDP to revise growth higher to 1.0 percent, from the advance estimate of 0.5 percent. We look for the final May estimate of the University of Michigan index of consumer sentiment to revise down the mid-month reading of 95.8 to 95.0. Finally, we forecast that durable goods orders grew 0.7 percent on the month in April, with non-transportation orders up 0.5 percent on the month.

The USD remained relatively supported last week as various policymakers indicated that the FOMC may well be close to further policy tightening. With this in mind, coupled with little in the way of extreme moves in the above, should allow the USD to trade within its range with a upside bias.

EUR This Week

We have a reasonably light week ahead for the Eurozone, with euro area flash PMI’s on Monday looking to edge up to 53.2 in May on the back of increased confidence within the services and manufacturing sectors. German IFO business climate should come in unchanged however at 106.8.

The most important event of the week will likely be found in Tuesday’s Eurogroup meeting, which should conclude with an agreement on Greece’s first review program. In particular, it will be interesting to see if they recommend/require Greece to pass any legislation. This would likely be deeply unpopular in Greece and could potentially push a “Grexit” closer.

 

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