Bye, Bye Sterling?

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

Sterling fell against the U.S. dollar for the second day in a row as disappointing economic data sends the currency, gilt yields and rate hike expectations lower. If Thursday’s shows consumer spending contracting more than expected, you can officially kiss the rally in goodbye. With slowing to 0.1% in March from 0.4% and holding steady at 2.8% instead of rising, a contraction in retail sales in excess of 0.6% could encourage the Bank of England to postpone a . Inflation is now at its lowest level in a year. The market is currently pricing in an 83% chance of tightening on May 10, down from 87.5% on Friday. Although most recent economic reports ranging from the PMIs to CPI have fallen, investors are latching onto the 2 votes in favor of an immediate hike in March. Now, even if retail sales decline, that does mean that the BoE will forgo tightening because in May, there will also be a and press conference making it the perfect time for the central bank to tighten. With that in mind, the BoE has also used the report and presser to telegraph changes the following month – so they could hold off till June. Either way, after Thursday’s retail sales report, there’s still 3 weeks until the next BoE meeting. Therefore a softer reading could send GBP/USD down to 1.41.

Meanwhile, rose above 1.26 following the Bank of Canada’s . The pair probably would have extended its rally to 1.27 if not for the , which climbed to a fresh 3.5-year high after took an unexpected tumble. Despite all of the improvements in Canada’s economy, Bank of Canada Governor and Deputy Governor did not feel that underlying issues are evolving well enough to send an unambiguously positive signal to the market. The tone of their press conference was cautious with Poloz saying the economy is not yet able to stay at full capacity on its own and therefore interest rates may need to remain below the neutral range. They also see companies hesitant to invest because of NAFTA risks. As a result, the BoC feels they need to be data-dependent and the pace of rate hikes is a considerable question mark as headwinds prevent a full recovery. Trade protectionism remains the biggest risk for Canada and they expressed no excitement about the recent progress in NAFTA talks. Given how much USD/CAD had fallen ahead of the rate decision, we believe their lack of optimism will lead to additional short covering that should take USD/CAD to at least 1.2680 if not all the way to 1.2750. Technically, the next key resistance for USD/CAD is between 1.2685-1.2700, where the February 9 swing-high meets the 50% Fibonacci retracement of the January-to-March rally and the next big figure.

As for the , it traded higher against most of the major currencies with the exception of the and . The was positive with the Fed districts citing more price pressures, real estate activity, loan growth, consumer spending increases, tight labor markets and a generally modest-to-moderate expansion in activity. However businesses voiced concerns about tariffs and the districts reported only modest wage gains despite widespread . There was nothing particularly insightful in the comments made by Fed Presidents , and . Thursday’s and reports are not expected to have a significant impact on the currency. The euro ended the day unchanged against the greenback. Its resilience in the face of softening data has been impressive and on Wednesday at least, it benefitted from Iran’s decision to stop using U.S. dollars for transactions.

For the next 24 hours, the focus will be on , the and dollars ahead of Wednesday night’s New Zealand and Australia’s . Both reports were expected to be strong with higher food and commodity prices lifting inflation in New Zealand and stronger employment conditions in the and sectors supporting job growth in Australia. Both currencies have been under pressure and are hovering below key resistance levels so good data could reinvigorate their rallies. For Australia, in particular, is expected to increase and the could fall but the number to watch is full-time job growth.