The Pound's Strength Against Euro, Dollar Holds as Service PMI Data Steadies

The British Pound is in a commanding position against its major peers as the latest figures concerning the UK's dominant services sector confirm no further post-referendum slip.

Services sector PMI

  • The Pound to Dollar exchange rate today: 1 GBP = 1.3346 USD
  • The Pound to Euro exchange rate today: 1 GBP - 1.1915 EUR
  • The Euro to Pound Sterling exchange rate today: 1 EUR = 0.8393 GBP

According to the latest Service PMI reading from IHS Markit and the CIPS the UK economy may have seen the worst of the post-referendum confidence shock come to pass.

The service sector accounts for around 80% of all UK economic activity - and the August release of the July survey which reads at 47.4 meets analyst expectations.

The on-target reading will aid the recent stabilisation in the GBP which has benefited from a short-covering rally over the course of the past 24 hours.

The Pound, "is still holding relatively strong against both the dollar and the euro; sterling is now trading at 1.33 against the former, and 1.186 against the latter, a remarkable performance given what is likely coming the currency’s way on Thursday," notes Connor Campbell at Spreadex.

We believe the recent strenght in GBP is precisely because of the event-risk posed by the Bank of England.

Traders will be unwilling to be caught out by any surprises, and the latest IMM data shows most speculative traders are betting against the Pound.

Therefore, to cut exposure and book profit, Sterling must be bought in order to close existing positions.

The recent strength in Sterling could therefore be fleeting as it is detached from fundamentals.

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Services PMI Suggest Worst May Have Passed

The much-watched Services PMI reading from IHS Markit and the CIPS will give us a clue as their survey of the sector is often used as an early gauge on GDP by economists.

The figure at 47.4 is certainly not good as a reading below 50 confirms the sector is contracting. Indeed, the chances of a 'mild recession' being encountered have increased on the back of the data.

"Output and new business both declined for the first time in over three-and-a-half years, and at the fastest rates since early-2009," says a note accompanying the data from IHS Markit and the CIPS.

Studies by Capital Economics suggest that, on the basis of past form, the all-sector PMI is consistent with quarterly contractions in GDP of around 0.4%:

Composite PMI and recession

"But activity for the whole of Q3 may not be quite as weak as the July PMI suggests. Given that the survey was conducted fairly soon after the referendum (between 12th and 28th July) there is a possibility that this could reflect an initial shock factor," says Scott Bowman, UK Economist with Capital Economics.

Indeed, the Services figure did meet analyst expectations and this could aid the British Pound, as was apparently the case on Tuesday the 2nd of August when the Construction PMI beat forecasts by reading at 45.9.

The Construction PMI data appears to have triggered the bout of short-covering on the GBP exchange rate complex which we have already mentioned.

There was some good news in the report which noted UK service providers expect business activity to
rise over the next 12 months.

David Noble, Group Chief Executive of the CIPS noted, "vestiges of hope were packaged up in the potential for new international business due to a weaker pound, and employment levels remaining steady."

Noble also suggests that with business optimism at its most fragile since February 2009, the sector will be looking for strong, significant monetary policy decisions from the Bank of England whether it is a change to interest rates or easing bias.

Over to you then Mr. Carney.

“There is a lot of nervousness about whether the BOE’s Quarterly Inflation Report will indicate that a technical recession is now very likely. An interest rate cut on Thursday is almost old news as most people expect it so the question is whether the BOE will re-start Quantitative Easing to ward off a recession," notes Nawaz Alil, UK Currency Strategist at Western Union Business Solutions.

Ali warns that if the Governor Mark Carney refrains from launching QE so early, then we think it’s probable to see the GBP/USD exchange rate rebound further in the short-term to as high as $1.3500 in reaction to a less dovish-than-expected BOE.

The chance of a bounce in GBP, inspired by an underwhelming policy response, is playing a strong hand in the recent GBP strength we have witnessed.

Beware, This GBP Strength Might be Built on Sand

Despite the short-term gains witnessed in Sterling, it is worth reminding readers that the strength could be fleeting.

There is a chance the July-August rally is a mere bounce within a broader decline which is yet to complete.

“GBP/USD is currently fluctuating in a 1.30-1.34 range, but we expect it will weaken further,” says Oliver Korber at Societe Generale.

Korber argues that near-term, GBP/USD has not yet fully discounted the BoE easing (unlike interest rates), while the Brexit economic shock and worrying external balances should continue to weigh on GBP over the medium term.

“We forecast the cable to fall below 1.30 by September,” says Korber.

A similar view is held of the GBP to EUR exchange rate at JP Morgan.

Analysts at the world’s largest investment bank believe Sterling is about to enter the second leg of its post-referendum decline with the GBP/EUR pair projected to ultimately reach 1.12.

Meanwhile, Korber's colleague at Soc Gen, Stephanie Aymes, notes that the GBP to EUR conversion has fallen below an eight year channel and has embarked on a multi-year decline.

Aymes is a technical strategist by trade, and argues first target of the decline ing GBP/EUR is located at 1.15/1.1429.

Short-term down strength is expected to be resisted by channel resistance near 1.2347.

Aymes says a move below 1.1765 will confirm resumption in the down-move initially towards 2013 lows of 1.1338 and even to 1.0965.

JP Morgan’s Meera Chandan says clients should stay bearish GBP and initiate a short vs the Euro.

“We have been recommending GBP shorts motivated by the view that there is not enough recession priced into the currency. This concession continued to compress this week as illustrated by GBP/USD which strengthened modestly even though UK-US yield spreads declined further,” says Chandan.

All eyes now turn to the Bank of England’s decision on interest rates and quantitative easing due on Thursday the 4th.

The event will see the Bank’s economists release their latest inflation and growth forecasts.

An aggressive Bank could well be the trigger to a second bout of GBP weakness.

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