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Brexit still unclear, but the pound gains strongly (afternoon analysis 23.01.2019)

23 Jan 2019 15:38|Marcin Lipka

Judging by the behaviour of the British currency, one could get the impression that the market expects only positive solutions for Brexit. Although their chances may have increased slightly, there is still a lot of uncertainty as to what form it will take. The pound may therefore be subject to considerable volatility. The zloty is stable, although tomorrow it may come under pressure should the data from the euro area be weak.

Pound the strongest since November

The Japanese currency was in a weaker condition today, and USD/JPY rose again to just below 110, after the Bank of Japan lowered its inflation forecasts for the coming year to 0.9%, due to, among other things, the low level of oil prices. However, it is still a relatively low level of the dollar to yen exchange rate - in mid-December it was still around 113.5. Its decrease resulted from a drop in the value of the dollar (due to a lower probability of monetary tightening in the US), as well as from an increase in the global level of risk aversion (and, among other things, significant decreases in the equity markets). However, USD/JPY should gradually recover to mid-December levels.

Apart from the Bank of Japan, no major macroeconomic events were planned for Wednesday. Although the Davos summit is taking place, it has a rather neutral impact on the currency market. In addition to the yen, which is now in decline, we have also seen significant changes in the pound. The British currency was strongly appreciating today, continuing the upward trend we have seen since the beginning of January. The pound was the strongest since November in relation to, among others, the dollar, euro and zloty. The reason is basically still the same, i.e. "optimism" related to the market expectations with regard to Brexit.

Nobody wants a "hard", chaotic Brexit - neither the UK, nor the EU nor Ireland. With the rejection of Prime Minister Theresa May's first plan, the chances of a greater role for the Parliament in leaving the ranks of the EU are increasing. It is precisely this fact that increases the chances of "soft" options , including delaying Brexit and a second referendum. However, nothing has actually changed at the moment, so in theory all options are still possible. Including the "hard" Brexit - the date of leaving the EU, 29th March, is approaching quickly and until it is extended, this worst case scenario for the UK economy remains quite real. Despite the current appreciation of the pound, there is still a great deal of uncertainty about the fact that nothing has yet been established. This, in turn, could still mean high volatility in the pound's exchange rates. In an optimistic scenario, the currency could gain 8-10% by year's end, although in the meantime it could fall by a few percent if the British Parliament is not able to work out any realistic Brexit option in the coming weeks.

The zloty cannot boast of such volatility and uncertainty. Excluding its exchange rate to the pound, the basket of the zloty has traded in a very narrow range today. EUR/PLN still oscillates around 4.29 and it is not expected to change today by much. This, in turn, may change tomorrow with significant events in the euro area. Data coming from the Polish economy has recently been weak and if they coincide tomorrow with lower prospects for the euro area economy, the zloty may be under more pressure, which seems to be overdue.

Tomorrow’s preview

Between 9:15 a.m. and 10:00 a.m. (CET), IHS Markit will publish preliminary data on PMI indicators for the industry and services sectors. In recent months we have seen a strong decline in the value of these indices - in the case of France even below 50 points which separates growth from decline of activity in the sector. Recent information on the euro area economies has not been encouraging, which has also been reflected in the weaker condition of the euro. Therefore, tomorrow's preliminary data for January may prove very important from the point of view of the single currency. However, no significant improvement in the PMI indices is likely to be expected, hence the potential for growth for the euro may be limited.

The European Central Bank (ECB) will publish a statement on monetary policy at 1:30 p.m. It is unlikely to change, so the focus should be on the press conference of Mario Draghi, chief of the ECB. Weaker-than-expected data and lower forecasts for 2019 for the euro area from the IMF are unlikely to have no effect on the members of the ECB. They can lower their projections for GDP growth and perhaps inflation. This would limit the chances of raising interest rates in the euro area this year and could increase supply pressures on the euro. In particular, if the ECB's reduction in forecasts coincided with worse-than-expected PMI readings, the euro's decline in value could be stronger.

23 Jan 2019 15:38|Marcin Lipka

This commentary is not a recommendation within the meaning of Regulation of the Minister of Finance of 19 October 2005. It has been prepared for information purposes only and should not serve as a basis for making any investment decisions. Neither the author nor the publisher can be held liable for investment decisions made on the basis of information contained in this commentary. Copying or duplicating this report without acknowledgement of the source is prohibited.

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