Sterling weakened on Friday after disappointing UK retail sales data dented broadening optimism about a currency that is enjoying its best winning streak against the dollar since 2014. Before Friday's drop, sterling had been rallying against the dollar, with traders welcoming positive noises from the European Union about negotiations for Britain's exit and growing risk appetite encouraging sterling bulls to add to their positions against a widely weakened dollar.
"The retail sales data paints a picture of a UK economy that is not enjoying a recovery that is being seen elsewhere across the world and the pound is reflecting that," said Timothy Graf, head of macro strategy for EMEA at State Street Global Markets. Figures from the Office for National Statistics showed 2017 was the weakest year for retail since 2013 and a drop in sales of 1.5 percent from November, as consumers squeezed by high inflation continued to keep a tight grip on spending.
Sterling was down 0.4 percent at $1.3845 at 1600 GMT on Friday, a full cent lower from its daily high as the dollar staged a broad recovery. Sterling had earlier hit $1.3945, its highest since Britain's June 2016 vote to leave the European Union. Sterling, however, remains on track for its longest winning streak against the dollar since 2014, with five straight weeks of gains.
Against the euro sterling was down 0.2 percent on Friday and 0.3 percent weaker versus the yen. The tepid retail sales figures rounds off a week of disappointing data for sterling bulls, including a softening of UK inflation in December.
"Consumer activity is quite closely correlated to sterling, so retail data is actually something that's well focused upon in order to gauge sterling direction," said Mizuho's head of hedge fund FX sales in London, Neil Jones. Long positions on sterling rose to their biggest since the third quarter of 2014 - a complete turnaround from March last year when pessimism over the currency peaked, according to positioning data.
Fuelling the optimism about sterling has been a decline in negative headlines about Brexit negotiations in recent weeks, which had been a dampener for sterling bulls for much of 2017. "The bigger picture is we have seen some favourable overtures from Europe on Brexit and that is also lifting sentiment," SSGA's Graf said.
The probability of Britain leaving the EU without a deal has fallen to 20 percent, from 25 percent in December and 30 percent in October, according to a Reuters poll published on Thursday. The president of the European Commission, Jean-Claude Juncker, said on Wednesday Britain was welcome to rejoin the trading bloc after it has left next year.
Still, Capital Economics said in a research note on Friday that the rise of the pound appeared to have more to do with the weakened dollar than reduced pessimism about Brexit, given sterling had moved far less against the euro. Despite the gloom around the retail sector, investors have added to their sterling holdings in recent weeks betting that a steep undervaluation on a trade-weighted basis against its rivals would disappear amid growing appetite for risky assets.