Pound drops as Brexit delay provides more pain for ailing UK economy

It hasn’t been a good day for UK data and the pound after the latest GDP, manufacturing and construction data all came in well below expectations this morning in an otherwise bullish day for risk assets after the US decided against raising import tariffs on Mexican goods. The GBP/USD dropped below Friday’s low, hitting a low of around 1.2685 so far, while the EUR/GBP hit a fresh 5-month high above the 0.89 handle.

Economy shrinks for two consecutive months

The data has taken a sharp downturn thanks to the Brexit delay. Manufacturing production had been rising consistently over the past few months due to stockpiling ahead of Brexit, but as the official exit date was extended from March 29, output in the sector slumped by the biggest margin in about 17 years as it slumped by 3.9% in April when a much smaller drop of 1.1% was expected. The impact of raised uncertainty and Brexit delay was also felt in the construction sector, where output fell again in April – this time by 0.4% month-on-month compared to an increase of 0.6% expected. And to make matters worse, the economy as a whole shrunk unexpectedly sharply. The 0.4% decline in output was not only worse than 0.1% expected, but it was also the worst monthly GDP reading since March 2016 and the second consecutive monthly decline. All this point to a poor start to Q2, leaving the pound in a limbo.

Brexit pain

Many analysts had predicted the economic costs of Brexit, but not many had imagined the process of leaving the EU would drag on for so long and cost so many parliamentary casualties. The prolonged uncertainty has caused many consumers and businesses to continually push back their purchasing and expansion plans, meaning that the economy has suffered even before leaving the trading bloc. The next UK Prime Minister better secures a good deal, as all this pre-exit pain could have been avoided with a no-deal exit from the outset. But if the UK still crashes out without a deal, then it will likely incur the worst possible pain pre- and post-Brexit. And that is exactly what many investors are worried about, which may explain why the pound just can’t catch a break.

Who will be the next Tory leader and PM?

Tory MPs have until 17:00 BST this evening to enter the race to become party leader and Prime Minister, with the 11 remaining contenders needing the backing from at least eight MPs. The candidates are announcing their policy ideas with frontrunner and hard-line Brexiteer Boris Johnson promising to cut income tax for those earning £50K or more.

UK wages data next

Meanwhile there will be more UK data on Tuesday to look forward to. The latest reading on Average Earnings Index is expected to point to a moderation in wages to 2.9% in the three months to April compared to a year-ago period, down from 3.2% in March. Anything less than that could see the pound take another tumble. Jobless claims are seen rising more modestly, though, by 12,300 in May compared to 24,700 the previous month, with the unemployment rate expected to have remained unchanged at 3.8% in April.  

EUR/GBP extends rally

Given the ongoing Brexit uncertainty and deteriorating UK data, as well as the EUR/USD’s breakout above the 1.13 handle, the EUR/GBP looks set to rise further. It needs to hold above old resistance circa 0.8900 to keep the bullish momentum intact, although the bulls will not be too concerned so long as the most recent at 0.8830 holds. The next bullish objective is around 0.8975/80, which is where the 78.6% Fibonacci retracement against this year’s high comes into play. Above this level, the next objective for the bulls is this year’s high itself at 0.9115.

Source: TradingView and FOREX.com