The spotlight was on the UK today as PM David Cameron delivered his speech on the UK's future relationship with the EU and as labour market data and Bank of England minutes were released. The speech ended up being so well signalled in advance it delivered nothing that we didn't know already. There will be a referendum on the UK's EU membership by 2017, he also stated that his aim was not to cause trouble, but to ensure a more "flexible and open" EU. Although he said that the EU would be greatly diminished without the UK as a member, he also warned that if the UK was to leave there would be no way to get back in. Cameron himself said he would fight to keep the UK in the EU; however, some of his euro-sceptic colleagues in the Tory party are likely to go head to head with the Prime Minister during the campaign trail. Thus, in order to avoid divisions in the party it is likely that any in-out referendum on EU membership won't take place before the next general election in 2015. In FX terms the prospect of a referendum is light years' away, hence it barely had any impact on GBPUSD. Although the pound is becoming more sensitive to domestic issues like the UK's status in Europe, if the Tories lose the next general election would a referendum even take place?
UK labour market a cyclical issue
The bigger driver of the pound was the strong labour market data for November and December. The unemployment rate fell to 7.7% in November, from 7.8% in October. The data for December was also encouraging with the number of people signing on for jobless benefits declining by 12.1k in the last month of 2012. The mysterious resilience of the UK labour market was the topic of a speech by newest MPC member Ian McCafferty last week. He said that companies were retaining staff because we have become a skills-specific economy. Since corporations are constantly refining processes to make themselves more efficient it meant that individual staff members have rich knowledge about how a function works, which makes them less dispensable to the business. Hence, combined with a low financing cost for business and signs that global markets are picking up, UK employers could afford to keep staff on even during recessions. This has led to a less "intensive" work force, McCafferty said that we may find that we have more time for that 5 minute chat with a colleague or that we take more "water cooler" breaks, but he disagreed that the UK has become less productive, instead saying that the UK's productivity has become more cyclical in recent years.
This is one piece of good news for the economy. However, the labour market data may not be so good for January after a number of high street chains collapsed at the start of this year including HMV and Jessops, with a loss of jobs. This could lift the claimant count rate at the start of 2013. However, if McCafferty's analysis is right then the labour market may not be a good gauge of UK economic strength. GBPUSD has been in recovery mode today and reached a high of 1.5890. A short term low seems to be in place at 1.5800, while 1.5930 - the 200-day sma - remains key short term resistance. This cross has stalled ahead of 1.59 this morning, which suggests that the market is still willing to sell the pound and its recovery may be short-lived. There is a lot of event risk for the pound this week with the release of Q4 GDP on Friday, expected to show a 0.1% contraction in growth in the fourth quarter of 2012. We expect this data to have more bearing on the future direction of the pound relative to the "mysterious" labour market data.
BOE members get more vocal about sterling
BOE Governor Mervyn King said in a speech last night that he expects weak growth in Q4. Likewise, the minutes from the BOE meeting earlier this month also showed that members still believe that downside risks to growth are elevated. The committee voted 9-0 to keep rates on hold, and only one member, David Miles, voted to boost QE. There was a definite increase in concern that the level of sterling was too high to allow the UK economy to re-balance. One of the reasons that Miles wanted to boost QE was because of a stubborn pound hurting exports. However, the BOE is not going down the BOJ route and there are some members who are concerned that increased inflation could hurt the economy along with the Bank's credibility. Higher inflation could indeed be corrosive for the UK economy this year as the latest wage data showed average weekly earnings fall to 1.4% in November, down from 1.8% in October.
The outlook for the pound remains weak in our view, and we could see 1.55 in GBPUSD in the medium-term. EURGBP is still a beneficiary of pound weakness, this cross is stabilising above 0.84 today and 0.8450 is the next key resistance level for this pair. If we get extremely weak UK GDP on Friday we may see EURGBP break above this level. However, for EURGBP to continue its move higher then we need to see the stabilisation in the currency bloc continue to help the euro edge towards 1.35 and beyond in EURUSD.
Yen continues to recover
Elsewhere, the yen continues to recover, although the pace of gains has slowed this morning. As long as USDJPY remains above 87.70 - a key support level and the 21-day sma - then we remain constructive on this pair. Watch out for the US house price index due out later today for November, as Treasury yields, and thus USDJPY, are likely to remain sensitive to US economic data.
One to watch: USDCAD
Also due out later today is the Bank of Canada interest rate decision at 1500GMT/ 1000 ET. This is expected to remain at 1%. The Monetary policy report also due at 1500 GMT is more important as the BOC has been at the more hawkish end of the central bank policy spectrum IN recent months. A "hawkish" report could push USDCAD below 0.9920 support towards 0.9850 then 0.9820, which is the bottom of its recent range. The topside could be capped at 0.9960 - the 200-day sma.
Chart 1: USDCAD - daily chart
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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