PRESSURE MOUNTS ON UK POUND AND US DOLLAR

The British pound has emerged as the most watched currency in 2019 asthe Brexit drama unfolds, as the United Kingdom looks to exit the European Union. The pound fell 4.8% against the US dollar, and there is a sense that more volatility is expected.

However year to date, the sterling has jumped 1.92% against the greenback on optimism that the UK might not leave the economic bloc after all.

The Bank of England has estimated that the negative impact of a hard Brexit, meaning a no-deal departure from the EU on 29 March, could lead to a GDP decline of between 4.75% and 7.75% by 2023.

These estimates are surrounded by uncertainty but it seems safe to assume that the impact would be considerable, says BNP-Paribas. It would also be front-loaded: confidence would drop in view of the jump in uncertainty of how business would cope with the disruption in supply chains, while household purchasing power would suffer from the increase in inflation due to the introduction of import tariffs and the sterling’s weakening.

A Reuters poll of currency analysts suggest sterling’s fate will be determined by how Britain’s exit from the European Union turns out. The British pound was forecast to gain over 8% to USD 1.38 in a year from about USD 1.28 in the third week of January.

Meanwhile, the US dollar and the Chinese yuan are reacting to the trade spat between the world’s two largest currencies.

The US dollar has been rallying for a few years, gaining a further 4% against a basket of currencies in 2018, but the majority of currency strategists polled by Reuters believe the surge is largely over.

After racking up its best performance last year since 2015, the dollar has lost momentum in recent weeks as the Federal Reserve signalled fewer interest rate hikes over the next two years and expressed caution about the US economic outlook,” Reuters said.

The 2 to 9 January poll of 75 analysts showed the dollar is now forecast to give up most of its 2018 gains over the coming 12 months, hurt by a US economy expected to lose steam as the year progresses.

Dollar’s loss may be euro’s gain, as the former fell 4% last year against the European currency. The euro was forecast to rise about 5% to trade at USD 1.20 in a year from about USD 1.14, according to the poll.

However, recent economic data has been soft, with third quarter GDP seen as the weakest in four years. In addition, uncertainty in France and Italy, means the European Central Bank will likely delay any tightening move.

The Chinese currency fell 1% against the US dollar last year, and much will depend on the efforts by the two countries to come to a resolution to their trade war. The past few weeks have seen the two governments taking confidence-building measures, and positively describing the tone of negotiations under way.

In January, Beijing said it was ready to implement more stimulus measures soon as its trade tiff with the US weighed on trade and risked a sharp economic decline than earlier anticipated.

The world’s second-largest economy will aim to achieve “a good start” in the first quarter, the National Development and Reform Commission (NDRC) said in a statement, indicating the government is ready to counter rising pressure on growth, according to Reuters.

Premier Li Keqiang said China achieved its key 2018 economic targets, which were “hard-won”, and seeks a strong start in the first quarter of 2019 to help meet this year’s goals, according to state television.

However, Moody’s Investors Service noted that the impact of an export-related downturn on China has been overhyped. Trade has made a smaller contribution to China's GDP growth in recent years and, combined with a changing trade structure, China's direct vulnerability to potential trade shocks has declined.

Also, the currently implemented US trade measures will impact only a relatively small portion of Chinese exports to the US, and we expect them to have a direct, but contained, effect on China's economy," says Lillian Li, a Moody's vice president.

Meanwhile, Asian currencies welcomed 2019 on a positive note, as trade tensions between China and the US started to ease. A lower trajectory for Fed tightening and diminished trade uncertainty both point to a topping in USD/Asia currency trade.

The Japanese yen has benefited from its safe haven status amidst global political uncertainty. The JPY should continue to strengthen and has already risen 0.17% this year, reversing its 0.91% loss last year against the US dollar, helped by its net current account surplus.