GBP: Short positions have been squeezed - RBS

Paul Robson, Research Analyst at RBS, notes that the short positions in sterling have been squeezed on news of both stronger pipeline inflation pressures and strong retail sales volumes.

Key Quotes

“This is inconsistent. Once short positions are cleared, we expect Sterling weakness to reassert.

It’s not often Sterling rallies on an upside surprise in producer input/import price inflation. Sterling’s weakness since the Referendum, declines that build on those seen since late 2015, is generally expected to raise input prices and ultimately headline CPI. The main surprise in the latest report is that pipeline pressures have started to build earlier than expected. It also means that higher inflation is going to hit consumption earlier and harder than expected as real wages take a hit. Strong growth in retail sales volumes has been largely driven by falling prices. Unless nominal wages rise to compensate, higher inflation looks set to drive a weakening in private consumption. In this sense, this week’s stellar knock-out sales report could be “as good as it gets”.

Ultimately, GBP will need to reach a level where the current account deficit is funded or closed. There will be a trade-off between this and GDP growth. Weaker domestic consumption is potentially a necessary condition for narrowing the current account deficit. At the same time, it makes funding the deficit harder as overseas investors may be less willing to invest in the UK if growth prospects are weak. In this sense, there are no easy options.

A carefully crafted and well thought out fiscal and economic policy/reform response has the potential to move the economy to a more favourable mix of currency level, exports and domestic consumption. Simply loosening fiscal policy to stimulate growth is likely to be only a temporary fix as the current account deficit will remain large and exports will not rise. Genuine reforms will take time, as will carefully targeted infrastructure spending. So it’s a long, as well as difficult path ahead.

With global markets in carry seeking mode, the UK’s lack of yield is a GBP negative. We continue to expect both a lower GBP/USD and higher EUR/GBP in coming months as Sterling continues its fall in trade weighted terms. We believe that the balance is shifting more to EUR/GBP topside.”