Sterling had a good month, outperforming both the euro and the US dollar in August due to sustained rallies that saw the pound rise 0.75% against the euro and 2.32% against the US dollar. The ongoing weakness in the US dollar explains some of the gains, but not the extent of the rise, which some analysts are starting to view as unsustainable.
Headlines over the weekend suggested that tax hikes, including rises in corporation and capital gains taxes were on the way. This news undercut the updates on the pace of the UK’s economic recovery in July and August and the Bank of England’s stance of refraining from cutting interest rates to 0% or into negative territory. The pound has begun the month on the front foot, but there are fears that it may lose some ground following widespread concerns about tax increases to pay for the financial support delivered during lockdown, as well as the ongoing impasse in Brexit negotiations.
While new taxation plans are expected to raise £20bn a year, the incoming tax changes will be implemented following the UK’s departure from the EU, when businesses and individuals may already be feeling the pinch, particularly given the current concerns that the government may walk away without a deal. The question for the market is not only whether a no-deal Brexit can be avoided, but whether the pound can continue to defy gravity for much longer as the downsides grow.
Tentative hope for growth in Europe, forlorn hope in the US
The euro is also benefiting from the overall weakness in the US dollar and the gains are supported by expectations that upcoming manufacturing PMIs for Europe will show moderate growth everywhere except France, which came in at a provisional 49, even with an increase in the number of coronavirus cases. Despite growing concern about Europe’s second largest economy Spain, who is registering a spike in cases of Covid-19, the expectation of an imminent upgraded growth forecast from Germany is helping the euro start the month on a positive note.
Data from China are also providing support for the euro and piling the pressure on the struggling US dollar. China's Caixin Manufacturing PMI beat estimates with 53.1 points in August, suggesting that the recovery is underway.
The same data added to the ill wind blowing for the US dollar. Together with the Federal Reserve’s announcement that it would hold interest rates at zero to prioritise supporting employment over curbing inflation and the ongoing political uncertainty due to the upcoming Presidential election, the US dollar is under immense pressure. A rise in oil prices – in part due to signs of growth in China – gave commodity-based currencies a boost that put further pressure on the greenback.
Commodity currencies to the fore
The Canadian dollar approached an eight-month high against the US dollar yesterday as the rise in oil prices, coupled with signs of economic recovery and increased risk appetite all gave the Loonie some support. The belief amongst investors is that the recovery of the labour market is happening faster in Canada than in the US, although this may change when the official data are released at the end of the week.
In the meantime, the Australian dollar took the spotlight as oil and iron ore prices rose following the news from China and the Reserve Bank of Australia (RBA) held the cash rate and the three-year yield rate steady at 0.25%. The accompanying announcement suggested that the RBA were poised to take further action if needed, but that positive signs of recovery suggested that they may not be needed. This may explain why the response to the RBA announcement was largely muted, although there may be more of a reaction tomorrow when the Q2 GDP data are released; analysts have forecast a contraction of 5.4%.
The New Zealand dollar couldn’t follow in its antipodean cousin’s footsteps as business sentiment dropped to -41.8% at the end of August. According to the ANZ business confidence indicator, it was a significant fall from -31.8% the previous month, and largely driven by the second lockdown in Auckland.