This week saw sterling surge against the euro and the greenback to its highest level since the Bank of England rolled out its post-Brexit stimulus package. The move was inspired by revelations of a surprisingly positive outlook for the British manufacturing sector. Off of charts, the move has both GBPEUR and GBPUSD near the top-end of their respective post-referendum trend channels. In the short term, it suggests further gains might be hard fought.
July UK Manufacturing PMI printed a shocking 53.3 against expectations of a 49.1 result. The reading above the 50.0 inflection point signals a return to positivity after a brief dip into negative territory following Britain’s EU membership referendum in June. While the result is no doubt constructive, the manufacturing sector in the UK is correlated with exports, which is perhaps one of the few parts of the British economy positioned to benefit from Brexit and the related sterling weakness. Furthermore, manufacturing accounts for less than 15% of the UK economy, so while its contribution is important, it’s unlikely to be able to save Britain from a recession. Rather all eyes will be on the Services sector outlook, published on Monday, which accounts for nearly 80% of GDP. The consensus forecast is 49.0 expected vs. 47.4 last month, which signals a bounce in sentiment, but still a negative overall outlook.
This week also saw the release of hotly anticipated American employment statistics. At a speech last week Federal Reserve (Fed) chairperson Janet Yellen implied that strong labor market data might be enough to trigger a rate hike before the end of the year, however, the result was a disappointing 151k jobs added versus expectations of a reading nearer to 180k. While the result dramatically reduces the likelihood that the Fed will hike rates in September, December is still very much on the table. The American employment disappointment has added to previous GBPUSD gains this week, contributing to the pair’s 3rd consecutive week of gains and marking the longest rally in 5-months.
Next week kicks off with the North American Labor Day holiday long weekend, meaning that on Monday financial markets in the United States are closed. Thin holiday markets could see elevated volatility surrounding the release of the July UK Service PMI number that day. The consensus forecast is for a reading of 49.0. While such a result would signal a state of contraction in the sector, it would also mark a bounce from the prior month’s initial post-referendum result (and incidentally 7-year low) of 47.4; which is a bit of a silver lining. In light of the surprise better than expected PMI result for manufacturing sector this week, sterling could be especially sensitive to an upside surprise. Speaking of potential knock-on effects from this week’s British Manufacturing outlook data, next Wednesday, July’s UK manufacturing output results will be released. Expectations are for a 0.5% month-over-month contraction driven primarily by seasonality. However thanks to the shock PMI number, there’s quiet anticipation for a strong result; to which the British pound would respond accordingly.
The headline event next week is Thursday’s European Central Bank (ECB) monetary policy update. Following a major injection of stimulus in March the ECB has been sidelined. On the rare occasion that ECB President Mario Draghi has spoken about policy publicly, his position has been once of patience. In a bid to reassure financial markets, Draghi has repeated a message that the ECB has more tools at its disposal. However, he has emphasized that the ECB would hold off acting again until the impact of both existing stimulus measures and Brexit can be more accurately measured. The argument about how much fuel is actually left in the tank (given near-zero interest rates and a behemoth QE program) aside, post-Brexit data out of the Eurozone has been relatively encouraging. After an initial blip, sentiment looks to have bounced back and no dramatic economic downturn of jump in Eurozone risk premiums has, as of yet, materialized; though it’s still early days.
Given that for the moment the economic uncertainty associated with Brexit seems to be contained to the UK, expectations are that Draghi could prove cautiously optimistic next week. Look for him to repeat his earlier assurances that the ECB is ‘ready and willing to act’. Additionally, Draghi is also likely to call for more support from elected officials In Brussels on the fiscal policy side. Given years of monetary policy stimulus following the global financial crisis, the effectiveness of incremental changes is diminishing. Thus central bankers the world over have been more vocal recently about the part fiscal policy needs to play in the years ahead.
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