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British Pound Shrugs Off Disappointing Services Industry Data as Markets Eye Brexit Deal

© IRStone, Adobe Stock

- GBP shrugs after October's IHS Services PMI surprises on downside.

- Activity, new work order growth slowed while costs rose says IHS.

- Data places U.K. economy on course for a Q4 and 2018 slowdown.

The Pound traded on its front foot during the opening session of the week even after IHS Markit data appeared to show activity within the U.K.'s largest economic sector cooling at the beginning of the final quarter. 

October's services PMI came in at 52.2, down from 53.9 in September and beneat market expectations for a reading of 53.4 from the index. 

Activity in the services sector still continued to grow in October although the expansion came at its weakest pace since March, when the economy was clobbered by a two-week period of snow and icy weather. 

Companies reported lower levels of spending among client firms during the period, which led new work orders to rise at their slowest pace since July 2016. 

The financial impact of the slowdown in current activity and new work was exacerbated another rise in operating costs, with both fuel bills and staff salaries having risen during the month. 

"The services PMI’s shortfall in October relative to its 12-month average, 53.9, adds to evidence that the economy is heading for a weak end to the year, due to slowing global growth and heightened risk of a no-deal Brexit," says Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics.

PMI surveys measure changes in industry activity by asking respondents to rate conditions for employment, production, new orders, prices, deliveries and inventories. A number above the 50.0 level indicates industry expansion while a number below is consistent with contraction.

Markets care about the PMI data because they are an important indicator of momentum within the economy. And economic growth has direct bearing on the rate of inflation and it is consumer price pressures that dictate where interest rates, which are the raison d'être for most moves in exchange rates, will go next.

"The larger-than-expected fall in the services PMI suggests that growth in the sector slowed sharply at the start of Q4," says Andrew Wishart, a U.K. economist at Capital Economics. "There was little good news in the sub-indices either, with both the new orders and backlogs of work balances falling, suggesting a rebound is unlikely in November."

The Pound was quoted 0.28% higher at 1.2990 against the U.S. Dollar following the release and has risen close to 1.5% in the last week, but is still down 3.7% for 2018. The Pound-to-Euro rate was 0.26% higher at 1.1420 and is up 1.3% this last week and 1.4% for 2018. 

Monday's data completes a hat-trick of surveys covering the outlook for the U.K.'s three largest economic sector, and the message from the three combined was decidedly negative. 

October's manufacturing PMI fell to its lowest level since the Brexit vote, after tensions over international trade and uncertainty about the U.K.'s future relationship with the EU hampered activity in the sector.

And the positive surprise of Friday's construction PMI, which rose at its fastest pace for 16 months, was overshadowed by Monday's services data.  

"Based on past form, the all-sector PMI in October is consistent with GDP growth of about 0.2%. If sustained over the remainder of the year, that would leave annual growth in 2018 at 1.3%, the weakest since the financial crisis. But we are optimistic on the outlook for growth next year," says Wishart.

With the U.K. economy on course to expand by around 1.3% for the 2018 year, growth looks to have slowed sharply from the 1.7% pace seen in 2017, likely due to a range of factors.

There was a steep weather-induced slowdown in the first quarter, President Donald Trump's so called trade war against China stymied activity in Europe during the summer and uncertainty over the outcome of Brexit negotiations has grown. 

Despite weakening growth, markets are anticipating that the Bank of England (BoE) will continue raising its interest rate over coming years, and potentially on two occassions inside of 2019.

Policy makers made clear last week the BoE intends to raise interest rates next year regardless of what happens with the Brexit negotiations because, whichever way Bank officials look, they see inflation pressures mounting.

The BoE's "hawkishness" provided the British currency with a tailwind last week, enabling it to build on gains wracked up after it emerged officials from the U.K. and EU may be close to agreeing terms of the U.K.'s withdrawal.

The Times reported at the weekend the negotiations are further along than is given credit for and suggested a deal that includes a solution to the controversial problem of the Northern Irish border could soon be announced. 

The BoE hiked the Bank Rate by 25 basis points, to 0.75%, back in August. That followed another rate hike back in November 2017, the bank's first since the financial crisis.

Changes in interest rates are only normally made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators. 

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