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Carney also touched on the risks tied to Brexit in a speech delivered yesterday afternoon, remarking that uncertainty over the outcome of the negotiations could create financial instability, negatively impacting the domestic economy at various levels.

An initial negative effect in this respect was reflected by this morning’s retail sales data, which fell short of expectations, contracting significantly in March and resulting in an overall contraction in 1Q 2017, which suggests that consumer spending is slowing. First-quarter GDP data will be released next Friday, and as a result of this worsening of the consumption trend, due to surging inflation, expectations point to a significant slowdown, from 0.7% to 0.4% q/q.

However, the pound’s negative reaction to retail sales data has so far been only marginal. The exchange rate has dropped from GBP/USD 1.2830 to almost 1.2780, and against the euro, despite a slight retreat, it has stayed in the EUR/GBP 0.83 area.

In light of the pound’s resilience, we have revised up slightly our near-term projection (1m) for sterling, from GBP/USD 1.22 to 1.24, which against the euro has therefore moved from EUR/GBP 0.87 to 0.85. This is because of expectations that the elections on 8 June could strengthen the May government, and in turn improve the United Kingdom’s bargaining power in talks with the EU on Brexit, offering ongoing support to the pound for as long as data do not start to provide sufficiently negative indications. This morning’s retail sales data were probably not considered “sufficiently negative”, as the BoE has already confirmed taken into account a slowdown in the consumption trend in the course of the year, which nonetheless – according to the projections included in February report inflation – should not prevent GDP growth from levelling off at 2.0% in 2017, a result achievable with an average growth rate of 0.4% q/q. This means that if next week’s data outline a slowdown in 1Q GDP growth to 0.4%, the negative impact on sterling could continue to prove modest, as such an outcome has already been taken into account by the BoE.

However, this does not remove downside risks tied to Brexit, with particular reference to the agreement on future trade relations with the EU. Considering also that the European Union (see above) does not intend to start negotiating this aspect until an agreement is in placed on the rights of citizens and on the exit bill, we have left unchanged our projections for the pound beyond the very near term, and continue to see downside risks concentrated on the 3m horizon, when tensions are expected to be at their highest, as negotiations will have just begun (immediately after the elections on 8 June), and the negative impact of rising inflation on the economy will have become more visible.

JPY – On stabilising risk aversion, the yen retreated slightly, returning into the USD/JPY 109 area. The exchange rate’s spell below the USD/JPY 110 mark should be temporary, barring an escalation of geopolitical tensions, or – in the very near term – a favourable outcome for Marine Le Pen at the first round of the French presidential elections on Sunday.

The BoJ meeting is scheduled next week (on Thursday), and will reassert that the curve control strategy remains in place. Beyond the near term, the prospect of a widening back of yield differentials should again weaken the yen. 

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