Pound's Services PMI Rally Against Euro Stalls on Equity Market Sell-Off

The pound has enjoyed a strong mid-week session after it was shown the UK's dominant service sector continues to grow.

Market and the CIPS have revealed that their Services PMI survey for January read at 55.6, ahead of consensus forecasts for a reading of 55.3 and better than the previous month’s 55.5.

Services account for about 80% of UK economic activity and this snapshot of the sector allows us to ascertain how well the economy is performing on a month-by-month basis.

According to UniCredit's Daniel Vernazza this PMI reading is consistent with a quarterly growth rate in the services sector of around 0.6%.

"It’s a reassuring number, particularly given the heightened financial market volatility in January that likely adversely impacted the banking and finance sector," says Vernazza.

The beat on expectations will likely underpin the recent gains seen across the British pound complex, much of which was sparked by Monday’s stronger-than-expected Manufacturing PMI release.

The pound to dollar exchange rate is higher after the release and is adding to its 3 week best at 1.4557.

The pound to euro exchange rate was meanwhile looking to expand on its base-formation and extend its recent recovery.

But, another sharp sell-off on the FTSE 100 has draged the GBPEUR conversion lower to 1.3177 - the euro tends to benefit against the pound when markets go into the red.

Declines should however be shallow we believe.

"When you look at the fundamental picture though, the weakness of Sterling looks a little overdone. The figures this morning show the economy remains in a moderate growth mode and consumer confidence is towards its highest for several years as unemployment continues to fall," says Andy Scott, economist at HiFX.

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UK Economic Growth Continues, But Some Concerns Linger

New business rose for the thirty-seventh consecutive month in January. The  rate of expansion strengthened to a six-month high, and remained stronger  than the average pace since the survey started in July 1996.

Encouragingly for Bank of England and sterling watchers, service providers raised employment at the fastest pace since last October.

However, there are some reasons to remain vigilant.

“Staffing growth remained relatively robust, which contributed to falling
backlogs for only the second time in the last three years. Some  respondents cited concerns that new work was not filtering through quickly enough to replace work finished,” says David Noble, Group CEO at the CIPS.

Indeed, despite the strong data there is not enough to convince us that the Bank of England’s policy makers will likely consider raising interest rates.

“Despite the uptick in growth, the increased uncertainty about the outlook and persistent lack of inflationary pressures means the majority of policymakers will no doubt be more worried about avoiding another downturn than whether the economy needs higher interest rates,” says Chris Williamson at Markit.

We remain cautious when it comes to reading too much into the British pound’s recovery until we get firmer indications that the pace of economic growth will stimulate inflation and therefore thinking at the Bank of England.

"The report is unlikely to have a material impact on the MPC’s deliberations ahead of tomorrow’s policy announcement and February Inflation Report. We continue to anticipate another 8-1 vote in favour of maintaining the Bank rate at 0.5% and a more dovish tone to the Committee’s near-term forecasts for growth and inflation," says Jonathan Thomas, Senior Economist at Lloyds Bank.

Pound to Dollar Rate Looks to 1.46 Now

The GBP to USD conversion has moved back towards the top of the current channel overnight, mostly due to the USD coming under a little pressure as a result of the US equity market and bond yield weakness.

“We are therefore watching services PMIs closely today, as an upside surprise could be the catalyst needed to see us break this channel and extend the recent rally towards more important trend resistance at 1.4550/1.4600,” says Robin Wilkin, Cross Asset Strategist at Lloyds Bank.

The euro does however remain a tough customer for sterling and there is not yet enough written into the charts to convince us that the current move lower is over.

Lloyds Bank are therefore awaiting a return to the trend higher in the EURGBP.