Soft Brexit? Labour and Conservatives “In Secret Talks”

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Despite seeing a heavy sell-off in response to the news last week that the Conservative party had failed to gain a majority in the snap elections, called by party leader and PM Theresa May, GBP has since stabilised and had started to rebound higher, before reversing and moving lower again today. So, what is going on?

There are two three drivers of the current recovery price action in Sterling:

Inflation & Wages

Firstly, the latest inflation data release yesterday showed that CPI rose to 2.9% over May. This marks a further increase from the 2.7% level seen in April and takes headline inflation back to its highest level since June 2013. Core inflation rose also, rising 0.3% from 2.4% in April to 2.7% in June.

Here is a breakdown of the data:

  • CPI inflation rose 0.2pp to 2.9% in May, the highest level in just
    over 5 years, with a rise in recreational goods prices the main driver
    of the headline increase.
  • Higher costs of package holidays, PC games and
    PC equipment, after the decline in GBP, were the main factors behind
    rise, which accounted for 0.2pp of the 0.17 change in the yearly rate.
  • Pipeline inflation showed continued signs of abating in May, with the
    6% y/y rise in input materials the lowest since last September.
  • The biggest contributor to this annual change came from crude oil, which
    contributed -2.63pp to the 12-month change. Factory gate inflation held
    firm at 3.6% y/y in May.

Following the release, we also had the release of earnings and employment data which showed that wage growth has fallen yet again, printing 2.1% in the 3 months to April. This latest fall-back in wage growth compounds the effect of rising inflation on British workers and is likely to weigh heavily on consumer activity.

Traders now await the latest assessment from the Bank of England on Thursday. Despite the persistent increase in inflation, political uncertainty is likely to keep the bank on the sidelines for now as markets await details of who will form the next government. A swift resolution to this matter could, however, put the focus on the BOE to address the inflationary environment sooner rather than later.  Indeed, if political uncertainty persists then GBP is likely to fall further, fueling more inflationary pressure.

Political Uncertainty

The issue of political uncertainty brings us on to the next reason why we saw GBP rallying yesterday. The DUP leader Arlene Foster, said that talks with Theresa May regarding a potential coalition government were “going well” and that she was confident of a “successful conclusion”.

The DUP was supposed to have a meeting with the Conservative party today for final talks, and it is widely expected that the two parties will strike a formal deal allowing for a coalition majority to be formed. The prospect of the Conservatives remaining in power is expected to benefit the Pound though it is unlikely that May will be able to push through all of her proposed policies given a resurgence in strength for the Labour party.

However, due to the tragic events of a fire in a London tower block, the meeting has been postponed and could be held off until next week. The postponement is fuelling concerns that Brexit negotiations could be delayed.

Soft Brexit?

Finally, there were reports yesterday that Labour and the Conservatives were in “secret talks” to pursue a softer Brexit which would include making concessions in exchange for retaining access to the single market. Such a result would clearly be beneficial for GBP and optimism linked to these talks is fuelling further buying. May has come under fire not just from opposition members but also from members of her own party over her stance on Brexit.

Technical Perspective

The selloff in GBPUSD stalled as price found support on a retest of the January & February highs around 1.2655. Following some consolidation at the level price has now retraced higher and is retesting the broken 1.2750s support. This will be a key pivot in the short term. A break higher here opens up the way for a retest of the next key resistance level around 1.2853 while a failure to breach the level should see price continue to consolidate in the current range (1.2650s – 1.2750s)

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