With Theresa May and Angela Merkel discussing how to break the Brexit negotiations impasse and the Bank of England ready to raise rates, the FT's Roger Blitz explains why the pound has been caught in a perfect storm.
Produced by Filip Fortuna. Filmed by rod Fitzgerald.
Hurricanes hit the UK about once every 30 years. But these days the pound seems to be caught up in one storm or another every other week. Two are threatening sterling simultaneously over the next few days.
The first is the one building up over Theresa May and Angela Merkel, as the UK Prime Minister and the German Chancellor discuss how to break the Brexit negotiations impasse. The second will appear on Tuesday in Westminster as Bank of England Governor Mark Carney explains to lawmakers why he wants to raise rates. Data on inflation, wages, and retail sales will also be making the UK weather. Currency analysts are nervously excited but investors are not so thrilled. Volatility is in the air. The pound, on Thursday, fell 0.6% on the deadlock in Brexit talks, only to rise 1% that same day on reports of the EU mulling offering the UK the two-year transition deal it was seeking.
Sterling continued to yo-yo on Monday. So investors are taking out extra protection against the pounds gyrations, driving up demand for one month implied sterling volatility. Investors look at Brexit prospects and BoE rate talk but they don't like what they see because the options for the Prime Minister and the Governor are narrow. Mrs. May is boxed in by party divisions on the one side and a tough EU stance on the other. Mr. Carney is boxed in by his own hawkishness, which has pushed the market into expecting a rate hike and driven sterling higher. So to back off now would drive the pound down and put the notoriously flip-flop BoE back to square one.
Economists say the UK has been down this road before and believe that Mr. Carney cannot afford to get it wrong. His credibility is on the line. The hope for Mr. Carney is a rate hike takes the heat out of inflation, but commentators say that a weak economy and uncertainty is a pretty rotten backdrop for the Bank of England to raise rates. They argue that central banks tend to raise rates only when the economy is strong. This looks to them like a crisis situation for raising rates and in those circumstances, they tend not to make much difference. Storms tend to give way to clear sunshine, but in the UK's case, that looks wishful thinking.