Jaisal Pastakia, Investment Manager at Heartwood Investment Management, comments on the fall of sterling to an eight year low
The single currency's strength this year is a far cry from the days when investors feared its demise. Year-to-date the euro is up 8% against sterling and 12% against the US dollar.
The euro’s resurgence this year has come on the back of an improving growth backdrop – note yesterday’s flash PMI reading for August – together with receding political risks, following the market favourable election results in the Netherlands and France. At this point, the upcoming German election in September does not look to be a market concerning event.
Contrast this train of improving events with the UK, where economic momentum looks uncertain. Monthly factory orders this year suggest that the sector is failing to capitalise from a weaker sterling and a pick-up in global trade. In addition, political uncertainty is likely to continue to weigh on the UK currency. Sterling fell on Thursday, despite the Government softening its Brexit ‘red lines’ on the role of the European Court of Justice.
Contrasting economic fortunes will most likely mean divergences in monetary policy. Investors have been pricing in the prospect of a reduction of monthly asset purchases from the European Central Bank. At the same time, investors have pushed out expectations of a Bank of England interest rate increase until the first half of 2019.
The euro’s fortunes this year are also at odds with the US dollar. Positioning in the US dollar reflects investors’ pessimism about the ability of the Trump administration to make progress on its legislative agenda, particularly on tax reform. Meanwhile, the US treasury market remains sanguine on US monetary policy and does not appear to be pricing in more than one rate increase this year, contrary to Fed policymakers’ forecasts.