Sterling bounces back, politics the real driver or . . .? - BBH

Analysts at Brown Brothers Harriman noted that after suffering its biggest loss in a year last week, sterling bounced back on Monday.  

Key Quotes:

"It overshot the upper end of the resistance band we identified at $1.3160 and made it up to nearly $1.3185 late in the European morning before sellers emerged.  We note that the Commitment of Traders showed that the net speculative position in the futures market was as long sterling as it has been in three years.  Disaggregating the data showed that the more than 15k contract surge was largely a function of short-covering (profit-taking?) than new longs being established.   

Sterling's recovery from its test on $1.30 before the weekend was helped by a report suggesting the UK Prime Minister May is considering a cabinet reshuffle following the EU Summit on October 19-20.  There was speculation that Johnson could leave, but this speculation, like Tillerson in the US, is chronic grist for the rumor mills.   It is difficult to know the veracity, but beside a short-term impact, the UK's challenges are so much larger than this or that cabinet official.   

Despite the 30 Tory MPs that are said to seek a leadership challenge, there seems to be a general recognition that ousting May could have disastrous consequences. In the first instance, it would deal a setback to Brexit negotiations. In the second, it would open the door to a Labour government, which according to recent surveys, enjoys greater popular support than the Conservatives.    

While political concerns help explain recent sterling movement, we think that the underlying direction is driven by economic considerations.  Here the news that may have been obscured by the political drama is that ONS revised up Q2 UK labor costs to 2.4% from 1.6%. This may be an important consideration for monetary policy.  Specifically, it makes a rate hike more likely.   

On the other hand, there may be more than meets the eye in tomorrow's report by the UK Office for Budget Responsibility.  It is expected to show new research that shows how it over-estimated productivity growth for the past seven years. While this sounds like old news, and it is, the implication is new.   

It means that the GBP26 bln fiscal cushion that Chancellor of the Exchequer Hammond secured last year is not so secure.  Slower growth means it will be considerably less exactly at the moment when there is greater domestic pressure to lift the austerity pay cap on public sector workers, lower the debt burden for students, and build more homes.   

The UK government seemed to appreciate the early signals from the Trump Administration of 1) support for Brexit and 2) encourage expectations for a friendly trade policy and a free-trade agreement.  This was always going to clash with the American First thrust of the new US administration.  The Trump Administration has made a couple of preliminary rulings against a Canadian airplane manufacturer who employs 4000 in Northern Ireland.  Reports suggest May, who depends on the Unionists from Northern Ireland in Parliament, appealed directly to the US President.  The US has also joined several other countries who do not want the EU and UK to decide how the allowable subsidies will be divided when the UK leaves the EU."