rahul.khanna's picture

What risks lie in GBP's recovery path?

GBP is likely to gain further after unemployment rate fell to a 6-1/2 year low.  Every aspect of the data was positive, with unemployment rate falling to 5.7% in December (consensus 5.8%), job creation of 103K in last quarter 2014 (consensus 50k), and the employment rate is 73.2%, last seen during December 2004 to February 2005 (and has never been higher since comparable records began).  Next key data release will be Friday when retail sales come out, which in our view is likely to be above consensus, in which case a further lift to GBP is likely.

EURUSD and GBPUSD are quite well aligned over the medium-term and have had a high correlation of 80% to 90% over the past year. We are now seeing little or zero correlation between the two currencies: one possible reason could be positive data coming out of UK while Europe has started a 60 billion Euros QE.  Though we see EURGBP continuing to head lower, GBP can not escape the reality of being in EU and any negative news that drags Europe deeper in to economic problems will have a drag on GBP.  Grexit seems to be the biggest risk facing the EUR, but any fallout seems less likely in the short-term as these negotiations may last for weeks if not months.

Eurozone data seems to be picking up, with Germany spearheading the recovery, also peripheral bonds seem to show little sign of contagion.  That is not to say the yields won't rise in the case of a Greek default, rather they are not likely to spiral out of control.  This added with the current stimulus of 60 billion Euros will ensure a steady albeit slow recovery as businesses feel more confident.  This will bode well for GBP as Europe still remains the single biggest trading partner and if its fortunes change, so will UK’s.