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Dour Day for Sterling Exacerbated by Services PMI Miss

Data confirms wage pressures in the U.K. are building - this has to be good for Sterling longer-term.

IHS Markit and the CIPS have today reported their U.K. Services PMI read at 53.8 in November, coming in lower than the 55.0 forecast and the six-month high at 55.6 registered in the previous month.

Despite the miss, a reading of 53.8 is indicative of comfortable expansion in the sector and the latest reading signals a solid increase in service sector business activity, even if the rate of expansion was slightly slower than seen on average in 2017 to date.

The miss nevertheless adds to the dour sentiment towards the British Pound which is struggling to find buyers in response to the ongoing impasse in Brexit negotiations.

No doubt the issue of Brexit negotiations are being felt by businesses as it was reported by IHS Markit and the CIPS that relatively subdued confidence amongst service sector businesses was linked to heightened economic uncertainty and ongoing pressure on margins from sharply rising input costs.

Furthermore, it is reported there were signs of pressure on operating capacity at service sector firms in November, as highlighted by a rise in backlogs of work for the third time in the past four months. In some cases, survey respondents linked rising volumes of unfinished work to recruitment difficulties and a lack of suitably skilled staff.

Concerns over employment activity in the UK's largest economic sector were raised as respondents reported the rate of staff hiring was the joint-slowest since March, but there are some silver linings to be had on this news.

“Purchasing managers voiced concerns that the dearth of skilled labour not only contributed to increased business costs due to demand for higher salaries, but that pressures on operating capacity intensified because recruitment had become more stilted," says Duncan Brock, Director of Customer Relationships at the Chartered Institute of Procurement & Supply.

From a Pound Sterling perspective, this focus on the cost of labour is interesting: The Bank of England raised interest rates recently in anticipation of higher inflation in the future owing to rising salaries, the rise in rates in turn proved supportive to the Pound.

Rising salaries are often the result of the pool of available labour in an economy shrinking as unemployment plummets; as is the case of the UK over recent months.

If these findings do in fact soon reflect in rising wages in official data, we could expect the Pound to find support as it suggests 'the squeeze on living' could be about to come to an end.

The Bank of England could therefore be expected to raise interest rates again in 2018 and 2019 in response to expectations for salary-fuelled inflation, and higher interest rate expectations typically prove supportive to the Pound.

The UK economy grew by 0.4% during the third quarter, up from the 0.3% rate of growth seen in the first and second quarters, which places the UK economy on track to grow by 1.5% for the 2017 year.

Despite the second-half uplift, full year growth is likely to be below the 1.8% seen in 2016 and substantially beneath the 2.2% expansion seen in 2015. Office for Budget Responsibility forecasts suggest the economy could slow even further once into 2018 and beyond. 

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Pound to be Supported

Tuesday’s data comes against a backdrop of heightened uncertainty for the economy, as well as the Pound, after a last-ditch effort by Prime Minister Theresa May to move Brexit negotiations onward in Brussels fell apart Monday.

"Despite a Brexit divorce deal falling at the last hurdle yesterday, we remain constructive on GBP. The immediate fallout should be limited as markets have become well versed with the idea that Brexit won't be solved overnight," says Petr Krpata, a strategist at ING Group.

The Pound was quoted 0.43% lower at 1.3415 against the Dollar during early trading Tuesday while the Pound-to-Euro rate was marked 0.34% lower at 1.1309. But strategists say it could go higher over the coming days as an agreement at the December 14 summit is still likely.

"We still think there's more upside to go – and are targeting GBP/USD at 1.40 on the assumption that transition deal will be agreed by 1Q18," Krpata adds.

PM May had gone to Brussels in the hope of securing EU backing to move Brexit negotiations on from the subject of divorce, to the questions of trade and transition, after December’s European Council summit.

Assurances on the post-Brexit Northern Irish border were the last of three European demands that needed to be satisfied ahead of the summit if talks were to move along.

Many see December’s progression of talks as essential to avoiding a so called “hard Brexit” or a “cliff edge Brexit” and to avoiding an exodus of financial services firms from the City of London.

Fears are that, without an early agreement on transition to whatever new regime results from the negotiations, some firms might be forced to begin relocating some of their staff and operations out of the City and into continental Europe in order for them to keep operating after Brexit.

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