Navigating Political Crossroads and Economic Resilience
Monday, June 24, week 26: The Pound Sterling (GBP) is poised at a critical juncture, caught between the uncertainties of an impending general election and signs of resilience in the UK economy. This report delves into the fundamental factors shaping the GBP's trajectory, examining the interplay of fiscal and monetary policy, economic indicators, and geopolitical influences.
Currency
Over the past five months, the GBP has experienced a mixed performance, influenced by a confluence of factors:
January - February 2024: The GBP faced downward pressure due to concerns about a looming recession and persistent inflation. The BoE's continued interest rate hikes, aimed at curbing inflation, also weighed on sentiment.
March 2024: The Spring Budget, which included a substantial cut to National Insurance Contributions (NICs), provided a temporary boost to the GBP. The market perceived the fiscal loosening as a positive signal for economic growth.
April - May 2024: The GBP experienced a period of indifference as positive economic data, including stronger-than-expected GDP growth and falling inflation, was offset by uncertainty surrounding the upcoming general election.
June 2024: The GBP found some upward support as CPI inflation fell to the BoE's 2% target in May. However, the upcoming election and the BoE's "finely balanced" decision on interest rates continue to create volatility.
Looking ahead to the next five weeks, the GBP's trajectory will likely be dominated by the following events:
Week 26 (June 24-30): The second estimate of Q1 GDP growth could provide further confirmation of the UK's economic recovery. A positive surprise could lend support to the GBP.
Week 27 (July 1-7): The general election on July 4 will be the most significant event for the GBP. A Labour victory could lead to a period of uncertainty as markets assess the potential impact of their policies.
Week 28 (July 8-14): The release of the unemployment rate for May will provide further insight into the state of the labour market. A continued rise in unemployment could weigh on the GBP.
Week 29 (July 15-21): The release of CPI inflation data for June will be closely watched by the market. A rise in inflation could increase pressure on the BoE to raise interest rates, potentially supporting the GBP.
Week 30 (July 22-28): The BoE's interest rate decision on August 1 will be a pivotal event. A rate cut could weaken the GBP, while a hold or a hawkish signal could provide support.
Fiscal Policy
The UK's fiscal policy has undergone a significant shift in recent years, moving from austerity to a more expansionary stance. The Spring Budget 2024 exemplified this shift, with the Chancellor announcing a package of net tax cuts aimed at stimulating economic growth.
The key fiscal developments impacting the UK economy and financial markets include:
NICs Cut: The reduction in NICs, both in November 2023 and in the Spring Budget, has provided a direct boost to household disposable income. This is expected to support consumer spending and contribute to economic growth.
Fuel Duty Freeze: The cancellation of the planned fuel duty rise has provided further relief to households facing high costs of living. However, it has also reduced government revenue and contributed to a wider budget deficit.
Non-Domicile Regime Reform: The reform of the non-domicile regime, effective from April 2025, is expected to raise additional tax revenue in the medium term. However, there is uncertainty around the potential behavioural response of those affected.
Public Sector Productivity Programme: The allocation of additional capital spending for a public sector productivity programme, focused on the NHS, is a positive signal for long-term economic growth. However, the lack of detailed departmental spending plans beyond 2024-25 creates uncertainty about the government's commitment to fiscal sustainability.
Over the next five weeks, the focus will shift from the implementation of existing fiscal policies to the potential impact of the upcoming general election. A Labour victory could lead to changes in fiscal policy, with a potential focus on increasing public spending and raising taxes on higher earners.
Economics
Economic Growth
GDP: The UK economy grew by 0.6% in Q1 2024, exceeding forecasts and ending the technical recession. The Office for National Statistics (ONS) noted that "services rose 0.7% amid widespread growth across the sector." However, the second estimate of Q1 GDP, due on June 28, could be subject to revision.
Business Confidence: The CBI Industrial Trends Survey reported that "sentiment in the UK manufacturing sector rose to 9 in the quarter to April 2024." However, businesses remain cautious about the outlook for investment and hiring.
Labour
Unemployment: The unemployment rate rose to 4.4% in February to April 2024, suggesting some loosening in the labour market. However, the BoE's Monetary Policy Report notes that "the labour market continues to loosen but that it remains relatively tight by historical standards."
Wage Growth: Annual private sector regular AWE growth eased to 6.0% in the three months to February. The BoE expects wage growth to continue moderating, but there are upside risks from the recent increase in the National Living Wage.
Price Changes
CPI Inflation: CPI inflation fell to 2% in May 2024, reaching the BoE's target. The ONS reported that "the largest downward contribution to the monthly change in both CPIH and CPI annual rates came from food, with prices falling this year but rising a year ago." However, core CPI inflation, excluding volatile items, remains elevated at 3.5%.
Producer Prices: Producer price inflation has moderated in recent months, suggesting easing cost pressures for businesses. However, the impact of the conflict in the Middle East on global supply chains could lead to renewed inflationary pressures.
Trade
Trade Deficit: The UK's trade deficit widened to £6.75 billion in April 2024, a near two-year high. The ONS noted that "imports rose by 7.2% to a near one-year high of £76.9 billion, while exports fell by 0.7% to £70.1 billion." The ongoing trade deficit is a potential drag on economic growth.
Over the next five weeks, the economic data releases listed in the Currency section will be crucial in shaping the market's perception of the UK economy. The general election will also have a significant impact on sentiment, with a potential Labour victory likely to lead to a period of heightened uncertainty.
Monetary Policy
The BoE's Monetary Policy Committee (MPC) has been raising interest rates since December 2021 in an effort to curb inflation. Bank Rate currently stands at 5.25%, its highest level since 2008.
The key monetary policy developments impacting the UK economy and financial markets include:
Interest Rate Hikes: The BoE's aggressive interest rate hikes have slowed economic growth and contributed to a cooling housing market. However, they have also helped to bring inflation down towards the 2% target.
Quantitative Tightening: The BoE began unwinding its quantitative easing programme in February 2022. This is reducing the amount of liquidity in the financial system and contributing to higher borrowing costs.
Forward Guidance: The MPC has signalled that it is prepared to continue raising interest rates if necessary to bring inflation sustainably back to target. However, the "finely balanced" decision in June suggests the MPC is becoming more cautious about further tightening.
Over the next five weeks, the MPC's August 1 interest rate decision will be the most important event for monetary policy. The decision will be heavily influenced by the outcome of the general election and the latest economic data releases.
Geopolitics and Market Themes
Conflict in the Middle East
Synopsis: The ongoing conflict in the Middle East is creating uncertainty for global markets, including the GBP. The conflict has the potential to disrupt oil supplies and global trade routes, leading to higher inflation and weaker economic growth.
Key Developments:
Disruptions to shipping through the Red Sea are causing delays and pushing up shipping costs.
Oil prices have risen moderately, but remain well below their 2022 peaks.
The conflict has heightened geopolitical tensions and increased uncertainty for businesses.
Market Impact:
The GBP has weakened against safe-haven currencies such as the USD and JPY.
UK equity markets have declined, reflecting concerns about the impact of the conflict on corporate earnings.
UK General Election
Synopsis: The upcoming general election on July 4 is a major source of uncertainty for the GBP. A Labour victory could lead to significant changes in economic policy, potentially impacting the currency's trajectory.
Key Developments:
Polls currently show the Labour Party leading, but the race remains tight.
Labour has pledged to increase public spending and raise taxes on higher earners.
The Conservative Party has warned that Labour's policies would damage the economy.
Market Impact:
The GBP has been volatile in recent weeks, reflecting uncertainty about the election outcome.
Options markets are pricing in a higher risk of GBP volatility around the election date.
Conclusion
Upward Support Scenario
The GBP could find upward support in the coming weeks if:
The second estimate of Q1 GDP growth confirms the strength of the UK's economic recovery.
The Conservative Party wins the general election, providing policy continuity.
The BoE maintains a hawkish stance on interest rates, signalling its commitment to fighting inflation.
The BoE's August 1 interest rate decision would be pivotal in continuing this outlook. A hawkish signal, such as a hold or a signal of further rate hikes, could reinforce the GBP's upward momentum.
Indifference Scenario
The GBP could experience a period of indifference if:
The economic data releases are mixed, providing no clear direction for the economy.
The general election results in a hung parliament, creating political uncertainty.
The BoE adopts a wait-and-see approach on interest rates, leaving markets guessing about its future actions.
The outcome of the general election would be the most important factor in determining whether this outlook persists. A hung parliament would likely prolong the period of uncertainty for the GBP.
Downside Pressure Scenario
The GBP could come under downside pressure if:
The economic data releases disappoint, suggesting the UK's recovery is faltering.
The Labour Party wins the general election and implements policies perceived as negative for the economy.
The BoE cuts interest rates, signalling concerns about economic growth.
The general election on July 4 would be the pivotal event for this scenario. A Labour victory, combined with the implementation of policies perceived as negative for the economy, could trigger a sustained period of GBP weakness.
References
Bank of England: https://www.bankofengland.co.uk/
Office for Budget Responsibility: https://obr.uk/
Office for National Statistics: https://www.ons.gov.uk/
Confederation of British Industry: https://www.cbi.org.uk/
S&P Global: https://www.spglobal.com/
GfK Group: https://www.gfk.com/
Reuters: https://www.reuters.com/
Bloomberg: https://www.bloomberg.com/
Financial Times: https://www.ft.com/
The Telegraph: https://www.telegraph.co.uk/
The Guardian: https://www.theguardian.com/
Newsquawk: https://newsquawk.com/
Financial Juice: https://www.financialjuice.com/
Semafor: https://www.semafor.com/
The Daily Upside: https://thedailyupside.com/
Stratfor: https://worldview.stratfor.com/