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British Pound Extends Lead after UK Manufacturing Industry Shrugs Off Cold Snap

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-IHS Markit Manufacturing PMI posts surprise increase for March.  

-Overall activity rises in March but momentum is now waning.  

-Strategists forecast subdued trading for Pound Sterling. 

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The Pound extended its lead over other major currencies Tuesday after the latest IHS Markit manufacturing survey showed British industrial firms shrugging off a period of inclement weather at the beginning of last month.

Tuesday’s Markit IHS Manufacturing PMI rose from 55.0 to 55.1 for March when markets had been looking for a decline to 54.8 given the period of snow and cold weather that swept across the UK at the beginning of the month.

The PMI measures 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.

“Companies continued to report solid inflows of new work from both domestic and overseas markets in March. New export orders rose for the twenty-third month running, with the rate of increase slightly above the average for the sequence (despite easing to a five-month low)," says IHS Markit.

Respondents in the survey attributed the March performance to succesful marketing campaigns, favourable currency exchange rates and improved sales volumes for existing clients. More than half of the manufacturers polled said they expect their own growth to pick up over the next 12 months.

However, while overall output growth may have picked up in March although the rate of new orders and employment gains moderated a touch across the sector and the index's average reading for the first quarter has slipped to a year-long low. This suggests a slower pace of growth in the months ahead than that seen during the last year or so.

"March’s Markit/CIPS report on manufacturing suggests that the recovery in the industrial sector lost a bit of steam in Q1," says Ruth Gregory, an economist at Capital Economics. "On the basis of past form, the output index still points to a slowdown in manufacturing growth to around 0.5% in Q1, well below the 1% plus rates seen at the end of last year."

Sterling was quoted higher against the Dollar, Euro Japanese Yen and Swiss Franc after the release. The Pound was 0.23% higher at 1.4080 against its US rival while the Pound-to-Euro rate was 0.01% higher at 1.1428.

"GBP maintains its well-worn ranges, notably having failed to break key levels in EUR/GBP at 0.8700. Softer UK manufacturing PMI should keep trading subdued," says Chris Turner, head of foreign exchange strategy at ING Group.

Manufacturing has been a relative bright spot in the UK economy ever since the Brexit vote of June 2016. The double digit fall in the Pound has made British goods cheaper for overseas customers to buy while a robust domestic economy has also fuelled demand. This saw industrial firms experience eight consecutive quarters of output growth in the period to the end of 2017, marking the longest expansion for the sector since 1988, although momentum has waned recently.  

"March’s heavy snowfall doesn’t appear to have had a particularly severe impact on supply chains. However, on the basis of past form, the output index still points to a slowdown in manufacturing growth to around 0.5% in Q1, well below the 1% plus rates seen at the end of last year," Gregory adds. "Of course, even if manufacturing growth does slow to around 0.5%, this would still be fairly strong by past standards. And encouragingly, with the new export orders index holding broadly steady in March, it appears as though the boost from the lower exchange rate is still providing ample support for manufacturers."

Snow and colder temperatures seen at the end of February and beginning of March are expected to dent UK economic growth for the first quarter. Already, retail sales tracked by the Confederation of British Industry fell sharply last month and economists forecast the official numbers will do the same when released later in April.

This weather-induced disruption adds to an already muddy picture of the UK economy after the fourth-quarter GDP report was also impacted by one-off events, such as the closure of a key oil pipeline in the North Sea during November. This  dented industrial production and lowered GDP growth for the period although other economic barometers such as the unemployment rate and wage growth numbers remained firm in amongst all of this. 

Unemployment fell back to a 42 year low of 4.3% in the three months to January despite a continued rise in the participation rate, as the economy created 168,000 new jobs during that period. This was twice the number of new jobs expected by even the most bullish forecasters. 

Meanwhile Bank of England data has shown wages picking up thanks to a tightening labour market and improved profitability in the manufacturing sector. Wage pressures are important for the economy and Pound Sterling because of their influence over demand growth and inflation. 

This is part of the reason why economists forecast the BoE will continue to raise interest rates this year even though the consumer price index is already in retreat from the 3.1% high seen in November last year. Inflation is what the BoE seeks to contain when it raises interest rates, which are themselves the predominant driver of exchange rates.

The Bank of England already raised the base rate by 25 basis points to 0.50% back in November 2017 and said in February that it will raise rates faster and further than the market expects if the inflation outlook evolves in line with its latest forecasts. It predicted the consumer price index would be above the 2% target until at least the first quarter of 2021 although consumer price inflation fell from 3% to 2.7% that same month. 

Pricing in interest rate derivatives markets, which enable investors to protect themselves against changes in interest rates while providing insights into expectations for monetary policy, suggests a greater than 50% probability of another rate hike in May with the market-implied bank rate on May 10 sat at 0.63%. Any change in this implied probability between over the next six weeks will have a significant impact on Sterling.

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