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Politics (Not GDP) The Driving Force For Sterling

Published 27/01/2017, 05:17
Updated 25/04/2018, 09:10

Wall Street opened higher the day after the Dow Jones finally closed above 20,000 for the first time. The enthusiasm for President Trump’s "America First" policies was less palpable in European markets. A slew of corporate earnings kept UK investors busy, leaving the broader stock market little changed.

The FTSE 100 has been teetering above 7130, its November peak for the last three trading sessions. The UK index is caught between rising global sentiment that catapulted every major American equity benchmark to record highs, and a recovery in the pound, which will hurt foreign earnings.

Diageo (LON:DGE), Whitbread (LON:WTB), BT (LON:BT) in focus

Still as it stands, those foreign earnings are doing very well, as demonstrated by today’s report from drinks-maker Diageo. Its shares were amongst the best performers on Thursday after reporting a 4.4% rise in sales. Diageo has been on the right side of Trump and Brexit; Americans are drinking more and those dollars are now worth more when converted to pounds.

Disgruntled BT shareholders are reportedly taking a leaf out of the Tesco (LON:TSCO) shareholder playbook and turning to their lawyers. BT shares were little changed on the news after having been pulverised by over 20% this week after the firm reported the impact of the issues at its Italian division.

Whitbread shares were propping up the UK equity benchmark after a rise in sales at Costa Coffee was not matched by its restaurant division.

Brexit slowdown still nowhere to be seen

The British pound briefly made a fresh six week high, before turning lower after data showed the British economy maintained its rate of growth in the fourth quarter. UK GDP rose by 0.6% in Q4 versus 0.5% expected, matching the 0.6% growth in Q3.

There is a concern that manufacturers have not been immediate beneficiaries of the drop in sterling. Consumer spending drove the growth but that’s not just a post-Brexit phenomenon, that’s a post-financial crisis phenomenon. Manufacturing and construction were flat over the year. Record low interest rates have encouraged consumers to splurge but business investment has lagged. Manufacturing typically involves a longer order cycle so we would expect the benefits of the weaker pound to feed through more gradually and for manufacturing growth to pick up sometime in the first half of 2017.

Politics (not GDP) the driving force for Sterling

The unenthusiastic reaction by currency traders reflects a sense that this could be as good as it gets for UK growth. So far the only major fallout from the EU referendum has been the drop in the pound which will inevitably feed through to higher prices and act as headwind to consumer spending.

Markets are forward discounting mechanisms and while the growth was faster than expected, it’s already well-understood the much lamented Brexit slowdown never happened. By that token, it’s also evident the Bank of England was completely wrong-footed by the resilience of the UK economy. What’s less clear is the extent to which markets will be self-correcting. If the pound recovers under a more neutral outlook for UK rates, the resulting inflation will not be as strong and not such a headwind to growth.

The data came at time when a rise in political certainty has carried the pound to close to its highest since October’s flash crash. It’s still politics (not economic growth) that is the driving force for sterling.

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