August 18th 2011: Preview - Will the retail sales data help Sterling defy gravity?
Sterling put in a remarkable performance on Wednesday as it rallied over 200 basis points against the dollar from a trough of 1.6350 following the weaker than expected labour-market data and Bank of England minutes. It peaked above 1.6580 with a further unwinding of short positions against the Swiss franc. Sterling is being seen as a defensive option given its position outside the Euro-zone and it could again recover quickly if the sales data is weaker than expected. Given the UK fundamentals, selling rallies looks much the preferred option at these levels against the dollar and Euro.
Sterling’s gains came despite even though the unemployment claimant count rose by 37,100 for the month, the biggest gain for two years, and unemployment rose to 7.9%. The Bank of England minutes recorded that the two members on the committee who had previously voted for a rate increase had joined the camp calling for no change with a unanimous vote for rates to left on hold for the first time in 15 months. The bank also edged slightly nearer further quantitative easing, although the minutes stated that the argument was not yet strong enough.
The retail sales data will be another test of sentiment and the short and medium-term impacts may diverge in view of what happened following the employment data. Anecdotal evidence suggests that underlying spending remains weak as consumer incomes remain under serious pressure. There was, however, some positive news from the British Retail Consortium which suggested that sales had risen 0.6% on a like-for like basis in the year to July. Underlying consumer spending has been weak, but for now it may predominantly be in areas which are not picked up by the retail sales data. The data is also always volatile on a monthly basis and there may also be an impact from consumers switching to low-cost brands. There was certainly a sharp drop in sales in the London area at the peak of the recent riots and any weakness here will be seen in the August data.
UK 10-year bond yields fell to record lows of 2.43% following Wednesday’s data while inflation is running at 4.4% to give negative returns of close to 2% - even the Swiss can’t engineer those kind of negative returns. If those nominal yields do represent a fair reflection of the outlook, then the economy is in for a very rough period indeed and the debt implications would guarantee a rapid UK credit-rating downgrade.
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