Global drivers dominate domestic factors

The pounds performance in August can best be described as multifaceted: strength versus the $bloc and commodity FX and under-performance versus the funding and European currencies. Such disparity in performance inevitably reflects the crossfire that GBP has been caught up in through the month as a result of developments in China and the subsequent spike in global market volatility.

By virtue of its status of a currency at the forefront of a potential rate tightening cycle, the vulnerabilities of GBP versus the low beta/funding currencies has been in evidence. 

"We have emphasized in recent publications that large sigma events in the global financial markets would leave sterling vulnerable against the backdrop of the UK's sizeable current account deficit", says BofA Merrill Lynch.

The domestic macro backdrop has continued to improve through the month as evidenced by the UK data surprise index. The economy continues to grow at a healthy clip supported by ongoing improvements in the labour market and wages growth. Nonetheless, EUR/GBP was nearly 5% higher during August than at the start of the month as the squeeze in funding positions saw significant EUR out-performance across the board. In doing so the rise in EUR/GBP has overshot its traditional anchor of 2yr swap yield differentials and the pair is expected to reverse course and for a renewed break below 0.70 once again in the month ahead.