The UK retail sales report was much weaker than expected, with headline sales falling 0.6% in June, the annual rate of sales growth slowed to 3% from 4.4% in May. Although retail sales figures can be volatile, there is a growing sense that the UK economy is slowing down sharply, and with the political backdrop deteriorating, the Bank of England needs to have a pretty solid reason for hiking rates when it meets next month.
Not even the internet could save it
The details of the report are worth noting. Declines in UK sales last month were broad based with clothing and household goods leading the way. Not even the internet could boost the retail sales figures: non-store retailing saw volumes fall by 1.4%, and the annual rate for non-store or internet sales retreated to 9.8% in June, compared with 16.1% in May.
Blame it on the weatherman…
The weather was likely a factor in the slump in sales. This summer has been one of the hottest on record with a consecutive series of hot days. It turns out then when the weather is this good in the UK we don’t go shopping and we hit the beach instead; the weather may have even put people off of shopping online, with more people choosing to be outside. However, some savvy internet shoppers may have delayed June purchases and instead wait for Amazon’s Prime Day that took place on 17th July, so it will be worth noting to see if Prime Day sales did enough to help retail sales recover in the July report.
The BOE conundrum
We believe that on balance the BOE will continue to hike next month, even with Mark Carney’s capricious history of saying one thing and voting another way at the last minute. However, the risk is rising that the BOE could surprise the market and fail to hike in August, which is now the biggest risk for sterling – even more so than warring MPs in Westminster.
Volatility set to pick up
GBP/USD dipped below the 1.30 level on the back of the report, it has since recouped some losses and is managing to hold on above 1.30, however, GBP/USD is the weakest performer in the G10 for the second day, and we expect it to remain under pressure for some time as momentum is to the downside. Key support lies at $1.2774, the low of the year so far. The problem with the pound right now is that volatility remains very low, volatility for 1-month at the money GBP/USD options is barely 8%, well below the peak in March when volatility reached above 10%.
Why the BOE is the biggest risk for the pound right now
GBP volatility has weathered the political storm well, however we expect to see sterling volatility rise in the short term for two reasons: firstly, we expect it could rise sharply in the coming weeks as we wait for the BOE decision on 2nd August. As mentioned above there is now a not-so-negligible risk that the BOE will fail to hike rates. Also, the UK’s Brexit deal with the EU needs to be hashed out by October this year, and the next few months are expected to be the hardest in terms of getting a deal that works for the UK and the EU. This is one reason why 3-month volatility in the GBP/USD options market has risen to its highest level since the end of April.
Overall, it could be a bumpy ride for sterling in the coming weeks. Citi’s Economic Surprise Indicator for the UK has fallen sharply, in line with the US. Thus the UK economic upswing that was getting started in Q2 may come to an abrupt end, and it could drag sterling lower with it.
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