Political storm clouds & weak UK GDP report deliver blow to GBP

AUD/NZD: Strong Australian employment report reinforces policy divergence

The major currency pairs has remained relatively stable overnight with USD/JPY rising above the 155.00-level. The biggest movers have been the Australian and New Zealand dollars. The Australian dollar has extended its advance overnight following the release of the stronger than expected Australian employment report for October. It has resulted in the AUD/NZD rate rising above the 1.1600-level for the first time since September 2013. The pair has risen sharply by just over 9% since the low point in April after President Trump’s “Liberation Day” tariffs announcement driven mainly by expectations that yield differentials between Australia and New Zealand will continue to widen.  The two-year swap spread between Australia and New Zealand has widened by around 120bps over the last 5-6 months. The widening yield differential in favour of Australia has been reinforced overnight by further evidence that the labour market in Australia is proving more resilient than expected. It was reported that employment increased strongly by 42.2k in October which was the biggest monthly increase since April. It was driven by a 55.3k jump in full-time employment that was only partially offset by a -13.1k drop in part-time employment. It compares to average employment growth over the last 6-12 months of between 14-19k. At the same time, the unemployment rate dropped by 0.2ppts to 4.3% from the cyclical high of 4.5% recorded in September. The developments support the RBA’s recent view that labour market conditions are a “little tight”. The RBA expects the unemployment rate to stabilize around 4.4-4.5% with only modest loosening ahead.

It is one reason why the RBA has become cautious over continuing to lower rates further. The RBA left rates on hold last week at 3.60% which is viewed as “mildly restrictive” and close to neutral. Recent developments including the stronger CPI report for Q2 have prompted the Australian rate market to price out further rate cuts. While the RBA has not stated clearly that the rate cut cycle is over, the Australian market is no longer confident that rates will be lowered further in the year ahead providing support for the Australian dollar. There are currently only around 9bps of cuts priced in for next year. In contrast, the RBNZ has already been more aggressive in cutting rates lowering their policy rate by a further 50bps last month to 2.50% while leaving the door open to further easing. The MPC noted last month that it “remains open to further reductions in the OCR as required for inflation to settle sustainably near the 2% target midpoint”.  Another weak labour market report from New Zealand for Q3 revealing the unemployment rate rose to a fresh cyclical high of 5.3% has reinforced expectations for further RBNZ easing as soon as this month. The New Zealand rate market is currently pricing in a small chance of a back-to-back 50bps cut.                    

RBA-RBNZ POLICY DIVERGENCE EXPECTATIONS LIFT AUD/NZD

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Weak UK GDP adds to political uncertainty weighing on pound

The pound has continued to underperform at the start of the European trading session following the release of the weaker than expected UK GDP report for Q3. It has resulted in EUR/GBP rising to a fresh high of 0.8844 as the pair extends its advance above the 0.8800-level this week. The report revealed that the UK economy slowed more than expected in Q3 when it expanded by just 0.1%. It was the second consecutive quarter of slower growth following expansions of 0.7% in Q1 and 0.3% in Q2. It was the slowest quarter of growth since Q4 2023. The BoE staff had been expecting growth of +0.2% in Q3. Weaker growth was driven by weakness in the manufacturing sector which was hit by JLR’s cyberattack shutdown. The manufacturing of vehicles was down -28.6%M/M in September. There was also evidence of the negative impact of Trump’s tariffs with US goods exports falling by -11.4%. Slowing growth momentum and weakness in the labour market are encouraging market expectations for more active BoE easing putting downward pressure on UK yields and the pound heading into the Autumn Statement. A significant package of fiscal tightening measures is expected to be announced putting a dampener on economic growth.    

At the same time, the pound was undermined yesterday by heightened political uncertainty in the UK. Prime Minister Starmer’s position as Labour party leader is coming under closer scrutiny in light of the party’s poor performance in the polls and his own dismal approval ratings which are among the lowest ever recorded for a UK prime minister. The rolling out of fiscal tightening measures in the Autumn Statement are unlikely to improve his popularity and could trigger a leadership challenge. It was already been reported that the Mayor of Manchester Andy Burnham is considering a leadership challenge and Health Secretary Wes Streeting is the latest to emerge as another potential challenger. In order to trigger a formal leadership challenge, a challenger must be sitting Labour MP which currently rules out Andy Burnham, and requires support from at least 20% of Labour MPs. Labour currently hold 405 seats in parliament so the threshold is 81 Labour MPs. The local elections in May of next year could be the key test of PM Starmer’s leadership. We expect the pound to weaken further if the market moves to price in a higher political risk premium.         

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com