British Pound Advances on Service PMI Beat

- GBP rises after better-than-expected IHS Markit services industry PMI. 

- Services momentum gathers pace in June with new orders at year-high. 

- Analysts say result improves odds of a BoE interest rate rise in August.

© IRStone, Adobe Stock

Pound Sterling advanced against rivals such as the U.S. Dollar and Euro mid-week as traders responded to a better-than-expected IHS Markit Services PMI reading, which showed momentum within the UK's largest economic sector gathering pace in June which makes the likelihood of a Bank of England interest rate rise in August all the more likely.

The IHS Markit services industry PMI rose to 55.1 during the month of June, up from 54.0 previously, when economists had forecast the index to hold steady at 54 following a sharp recovery from earlier lows seen back in May.

"Today’s UK services figure rounded off a hat-trick of strong PMI readings for June. With the UK so heavily reliant upon the services sector, there is reason to believe that today’s figure will drive Q2 GDP towards the 0.4% mark. Crucially, markets will be focused in on the impact today’s figure will have upon rate hike expectations, with today’s sharp rise in the Pound reflecting the fact that the August meeting could be a prime opportunity for the MPC to raise rates once again," says Joshua Mahony, a Market Analyst at IG in London.

UK services companies saw business activity rise at the fastest pace for eight months in June as the effect of earlier snow-related disruption dissipated, giving rise to a flood of new work that saw order books swell at their fastest pace since May 2017, according to IHS Markit.

Business and financial services were the strongest performing sub-sectors.

"June’s Markit/CIPS services survey provides further reassurance that the slowdown in GDP growth in Q1 was temporary and raises the chances that the MPC will vote to hike interest rates in August. The rise in the headline business activity index from 54.0 to 55.1 far exceeded expectations (54.0) and took the balance well above its Q1 average of 53.1," says Ruth Gregory, an economist at Capital Economics.

Succesful product launches, new marketing campaigns and improving economic conditions in the UK were among the reasons cited by respondents to the survey for the better performance in June.

However, and on the downside, skills shortages were beginning to bite in some segments of the industry, slowing the pace of hiring growth. Some companies also reported having reduced headcount in order to contain operating expenses. 

Furthermore, cost burdens were more pronounced during the recent month, with an increase in energy costs and rising levels of staff pay both squeezing company margins during the period. 

"The index now points to quarterly growth in services output of around 0.5%, a welcome improvement on Q1’s 0.3% rate. What’s more, the strengthening of the survey’s forward-looking balances indicate that solid growth in the services sector should be sustained in the coming months," Gregory adds.

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, covering the UK's three largest commercial sectors, 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 dicate where interest rates, which are the raison d'être for most moves in exchange rates, will go next.

"The Services PMI print today concluded a trifecta of phenomenal PMI figures from the UK this month, posting 7-month highs at 55.1. The bullish figures from the Services, Construction and Manufacturing sectors, along with GDP beating estimates last week, prove the UK economy is gaining momentum once again," says Balraj Sroya, a sales trader at currency exchange firm Foenix Partners. "As a result, the likelihood of the Bank of England raising rates this summer has strengthened." 

Wednesday's result is better than even the most bullish forecasters had anticipated although Pound Sterling's reaction was mild, likely having been tempered by fresh unease over the trajectory of the Brexit negotiations and stability of Prime Minister Theresa May's government. 

Above: Pound-to-Dollar rate shown at hourly intervals.

The Pound was quoted 0.01% higher at 1.3195 against the Dollar following the release while the Pound-to-Euro exchange rate was 0.11% higher at 1.1328.

Sterling was also higher against most other developed world currencies.

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

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Pound Turbulence and Cabinet Resignations in Prospect

Wednesday's data comes just days ahead of a crunch cabinet meeting that will see Prime Minister Theresa May attempt to sway her cabinet with a new proposal for the post-Brexit relationship between the UK and European Union. This meeting itself precedes the release of a Whitepaper that is set to outline the government's latest proposals. 

PM May will meet the cabinet at her countryside retreat, Chequers, and attempt to reach an agreement that enables her to avoid confrontation with Brussels and renewed deadlock in the Brexit negotiations.

At issue is how to satisfy a seemingly impossible EU demand that the integrity of its so called single market and customs union be preserved while also avoiding a "hard border" on the island of Ireland. Presumably, a so called hard border can only be avoided if either the UK remains a member of the single market and customs union or if EU agrees to an absence of border infrastructure despite the UK going off to pursue its own post-Brexit trading arrangements. 

Any continued membership of either would see the UK remaining subject to the Brussels lawmaking machine and could mean ongoing free movement of people, even if it is repackaged as something else. Such a relationship would be contrary to the idea of independence from the EU and could place the UK on track for what would be an exit from the EU in name only.

Fears are that the proposals could lead to a wave of resignations from the cabinet and renewed concern for the stability of the UK government. This would almost certainly be bad for the Pound.

"The prospect of appeasing the Hard Brexit faction of the cabinet looks low. We therefore see a high chance that cabinet resignations could unfold over the weekend. That would obviously prompt speculation of a leadership challenge, throwing us into a period of political uncertainty from next Monday," says Derek Halpenny, European head of global markets research at MUFG. "Pound volatility next Monday looks like an increasing prospect."


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Bank of England in Focus

Wednesday's data also follows similar surveys of the manufacturing and construction industries. Both showed conditions in the two sectors improving during June, following a weak start to the year. 

The services industry is the UK's largest economic sector so the PMI data is closely watched by markets. It was among the few positive contributors to GDP growth, which slowed markedly, in the first-quarter.

"The rise in the services PMI to its highest level since last October will fan expectations that the MPC will hike interest rates in August, but the survey is not always a reliable indicator for the official activity data which will ultimately determine the Committee’s next step," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics. "The weighted-average of manufacturing, construction and services PMIs is consistent with quarter-on-quarter growth in GDP of about 0.4% in Q2, matching the MPC’s forecast and its assessment of trend growth. But since 1998, the PMI’s forecast for the preliminary estimate of GDP growth has been wrong by 0.25pp on average."

Office for National Statistics data showed last week that services industry output rose by 0.3% during the three months to the end of March, offsetting an almost 1% contraction in construction and manufacturing industry output for the period. UK GDP growth slowed 0.4% at the end of 2017 to just 0.2% for the first quarter.

The first-quarter economic slowdown, and a steep decline in UK inflation, led the Bank of England (BoE) to abandon the idea of an interest rate rise in May. This dented the Pound and left markets looking to the August meeting for the next possible move.

"I would have voted to raise Bank Rate at the MPC’s May meeting had data on the economy held firm. What we saw ahead of that meeting was a string of weak data suggesting consumer spending might be faltering," says Andy Haldane, chief economist at the BoE and a member of the Monetary Policy Committee (MPC), in a speech last week. "I believed there was option value in waiting to see if these data signalled the start of a lasting retrenchment by households, or were instead a temporary snow or statistical blip."

Haldane was one of three MPC members to have voted in June for an increase in the UK's main interest rate, after eschewing such a decision in May. Many economists now expect the Bank of England will go ahead and raise rates in August, although financial markets have been slow to take note.

Sterling-Overnight-Index-Average pricing on the morning of Wednesday 04 July implied and August 02 Bank Rate of 0.59%. If markets were as confident in the likelihood of an August rate rise as Andy Haldane appears to be in the merits of one then that implied rate would be closer to the 0.75% the actual Bank Rate will sit at the next time the BoE pulls the trigger.

If and when financial markets become more willing to bet on an August interest rate rise then this implied rate will rise further, and the Pound with it.


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