Volatility will again be a key feature, as Sterling faces a series of extremely important set-piece events with key data releases and central bank action during the week. The most likely outcome looks to be for a weak correction, especially against the Euro, before renewed selling pressure and a retreat to below 1.55 against the dollar. The underlying Sterling trend remains negative on evidence that monetary policy conditions will remain ultra-loose throughout 2013. Fear would intensify on another very weak services PMI reading and set the stage for very sharp Sterling losses. Sterling has been subjected to heavy selling pressure during the first month of 2013, and the next week will be pivotal for February and wider first-quarter direction.
The latest PMI services-sector reading, released on Tuesday, will be extremely important for confidence. From a reading of 50.2 for November, there was a sharp decline to 48.9 for December. This was only the second reading below 50 in over three years and the weakest reading since May 2009. The data made a fourth-quarter GDP deficit inevitable and raised major fears over the outlook, especially given the importance of the services sector for the economy as a whole.
PMI data is subject to monthly volatility and a quick bounce back to above the 50 level this week would provide some degree of reassurance over the underlying economy and suggest that a triple-dip recession can be avoided. In contrast, further monthly deterioration would trigger serious alarm over the economy with a renewed plunge in Sterling.
Chancellor Osborne has already received the dreaded vote of confidence from the Prime Minster and another sub-50 reading, together with a weak reading for industrial production on Thursday, would go a long way to seeing the Chancellor dismissed from his post.
The major ratings agencies are already sitting poised with their fingers on the AAA downgrade trigger and another weak PMI reading could well be enough to unleash the downgrade.
As far as monetary policy is concerned, Thursday will be extremely important for Sterling. The Bank of England will announce its latest monetary policy decision. Since January's meeting, there has been some evidence of improved lending conditions and Sterling has weakened. Both these factors should be enough to convince the MPC that no further action is required this time around. In these circumstances, if the Bank of England does expand monetary policy again, this would be extremely negative for Sterling.
Earlier on Thursday, Mark Carney comes to town with testimony to the House of Commons Treasury Select Committee on his appointment as the next Bank of England Governor from July. Carney has already caused a stir with comments suggesting that central banks should move towards a policy of nominal GDP targeting rather than a narrow inflation target. Carney has since back-tracked slightly from the comments, but he is certain to favour an important shake-up in UK monetary policy and testimony will be watched very closely.
There will also be a strong suspicion that the UK government and Chancellor in particular will be looking to the Bank of England appointment change as cover for the shift to a much more aggressive set of economic policies as the electoral cycle becomes increasingly desperate for the government. Carney will surely aim to be circumspect at the hearing, but hints over more scope for wider and more aggressive monetary policy action are likely which would have a negative Sterling impact.
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