British Pound Slides Vs Euro and G10's Even as Manufacturing and Industrial Production Gather Pace

Manufacturing output and exports both gathered pace in November, which is positive for fourth-quarter GDP numbers due later in January.

The Pound slipped into the red against most of its G10 rivals Wednesday as traders shrugged off a volley of strong economic numbers from the UK, in favour of profit taking in the wake of several days worth of strong gains for the currency.

Manufacturing production numbers for November were the star of the show among the morning’s economic reports, with output from the sector shown growing by 0.4% during the month, faster than the 0.3% growth forecast by economists.

Broader industrial production also rose notably in November, rising by 0.4%, up from the 0.2% growth for October but in line with the consensus forecast from economists.

The manufacturing component of the industrial production survey was the greatest contributor to the upward move over the broader three months to the end of November, itself the result of an uptick in orders for transport equipment.

However, a rebound in energy output was the strongest contributor to growth during the November month, given unusually cold weather that boosted demand for household fuels.

“The 0.4% rise in manufacturing (which also appeared to be broad based) and 0.4% rise in overall industrial production, leaves the sector on track to provide solid support to overall GDP growth,” says Paul Hollingsworth, a senior UK economists at Capital Economics.

Britain’s beleaguered construction industry also showed signs of having come back to life, according to the Office for National Statistics data, with output rising by 0.4% in November.

This was slower than the 0.7% growth forecast by economists but, nonetheless, represents a marked improvement from the contraction reported in October.

Previously, construction output was thought to have fallen -1.7% in October although the ONS revised this number higher Wednesday, which places the fall at a lesser -1.1%.

Separately, Britain’s trade deficit widened further than was forecast during November, expanding to -£2.8 billion for the month, a deterioration from the -£2.3 billion seen in October.

“Although the trade deficit widened... the fact that goods export volumes (excluding oil and erratics) rose by 2.6% on a three-month on three-month basis, while imports were flat, suggests that net trade could boost growth in Q4, after providing no contribution to growth in Q3,” Hollingsworth notes.

While accounting for only around a tenth of the economy, manufacturing is an area of increasing importance for the UK.

It is sensitive to Brexit outcomes around trade but also has a historic opportunity before it given a double digit devaluation in the Pound Sterling since the referendum of 2016. This has made British goods cheaper for international customers to buy and stoked hopes of an industrial renaissance for industry across the UK.

Optimism and activity among Britain’s manufacturers has risen steadily since the 2016 referendum, reaching a 51 month high in November according surveys of the industry by IHS Markit.

Last week, the IHS Markit Manufacturing PMI for December showed sentiment easing back from the multi-year highs seen previously but, nonetheless, remaining at healthy levels.

The Pound was quoted 0.10% lower at 1.3516 against the US Dollar around the London close Wednesday while the Pound-to-Euro rate was marked 0.38% lower at 1.1300. The Pound also weakened against the remainder of the G10 basket.

Above: Pound-to-Euro exchange rate shown at hourly intervals.

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UK Economy Regaining Momentum, Wages Rising

Wednesday’s industrial data comes at a pivotal time for the UK economy, which has recently shown signs of regaining some of the momentum it lost over the first half of 2017, but will be tested by further challenges relating to Brexit in the year ahead.

“With consumer spending appearing to have held up well, quarterly GDP growth of 0.4% or 0.5% looks likely, which would see growth in 2017 as a whole come in at 1.8%, barely different from 2016’s 1.9% rise,” says Hollingsworth.

Economic growth has risen from 0.3% per quarter in the first half of 2017 to 0.4% in the third quarter and, according to Hollingsworth, may even reach 0.5% for the final quarter. Data for the last three months of the year will be released later in January.

British and European negotiators are set to begin discussing arrangements for a transitional deal later in January, with talks covering the future trade relationship between the UK and the EU likely to begin in March.

Progress of discussions will be key to whether the economy can sustain its newfound momentum far into the New Year, as well as being important for whether or not the Bank of England raises interest rates again over the coming months, or if it sits on hold. Both Brexit and the Bank of England will be important for determining the trajectory of Sterling in 2018. 

"We continue to expect the MPC to raise rates on two occasions this year, with the next increase coming in May. The probability currently stands at around 40% and so there is still ample scope for short-term yields to rise, which coupled with progress on transition talks will help lift the pound further," says Derek Halpenny, European head of global markets research at MUFG.

The Bank rate now sits at 0.50% after the Bank of England reversed August 2016's post-referendum interest rate cut back in November.

In addition to being contingent on a smooth Brexit, further interest rate rises will depend as much on wage and economic growth continuing to pick up during the months ahead. Already, there are signs that they just might. 

"Our bullish outlook for the pound in 2018 assumes that the squeeze on real wage growth, that undermined economic activity in 2017, will start to reverse this year as wage growth picks up and we begin to see a moderate reversal in inflation and the GBP-induced lift to inflation reverses," notes Halpenny.

Tuesday saw IHS Markit report strong gains in the UK jobs market over the course of December, and deepening staff shortages, which continues to support increases in wage growth. 

This is just the latest evidence of emerging pay pressures in the UK. The Office for National Statistics reported twice on wages in December. It announced that wage growth was faster than previously thought during the three months to the end of September and that pay pressures continued to build in October

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