A look at how the British pound will react after the key events this week and today's Cabinet meeting in Chequers
Manufacturing PMI
On Monday, the UK Manufacturing Purchasing Managers' Index (PMI) crawled up towards 54.4 from the 54.3 number in May. Although the number exceeded expectations of 54.0, investors remained doubtful on the state of UK's manufacturing industry due to the insignificant rise relative to earlier months. Moreover, the 2nd quarter of 2018 which ended this June was the weakest among the last six quarters.
This relative slowdown
does not point for a healthy British economy given that the manufacturing
sector accounts for around 10% of UK's economic output. On the upside, the
Manufacturing PMI number has not reached the contractionary levels below 50.
The slowdown is mainly attributed to the possibility of global trade tariffs,
Brexit, weak British Pound, and inflationary environment from the cost
side.
Construction PMI
On Tuesday, the UK Construction PMI surprised investors and grew at the fastest
rate in seven months. This month's number was also the third month in a row
that the sector grew following a contraction in March. The Construction PMI
printed at 53.1 versus the estimated number of 52.5 and growth from this sector
came mainly from residential and commercial properties.
Services PMI
On Wednesday, the UK's Services sector which accounts for around 80% of the
British economic output showed strong positive momentum with the Services PMI
climbing from 54 to 55.1 while beating expectations for zero month-on-month
change. Business and financial services sectors both performed well alongside
consumer spending which was mainly driven by the hot weather.
PMIs and the Bank of England
The PMIs should be watched closely next month as they will play an important role in determining whether or not the BoE will increase interest rates. A reflection of optimism from these numbers will prove that the weakness seen in the British economy earlier this year was only temporary and was not related to Brexit.
After the release of
June's PMIs, the market started pricing in a 67% probability for a rate hike in
August. The high chance for a rate hike is also attributed to the rising
inflation which is picking up from the previous 2.4% level due to rising
business costs and surging oil prices.
UK Cabinet Meeting
The greatest risk to raising interest rates will be a hard Brexit. Today, Theresa May and her cabinet members are meeting in order to agree on the deal negotiations for Brexit. It is going to be a difficult day for Theresa May since her cabinet includes differing views and this was reflected in previous months' disagreements. For the cabinet, the main issue at hand is trying to find a way to avoid a "hard border" on the island of Ireland which is only possible if the UK remains part of EU's single market and customs union.
All the currently
discussed solutions suggest that the UK will remain subject to EU laws and
freedom of people's movement which contradicts the idea of true independence
from the EU. The market will be watching the release of the cabinet's
whitepaper which will include the new governmental proposals. Investors are
worried that the outcome of today's meeting will contribute to resignations of
certain ministers and instability in the UK government.
Conclusive Statement
If the whitepaper points towards an agreement for a soft Brexit and we don't witness any shake off in the cabinet following the release, then the British Pound will have all the right reasons to rally higher. The combination of positive economic data, possibility of an interest rate hike, and a soft Brexit will allow the Sterling to rise all the way towards the 1.40 level. The FTSE 100 will also benefit from the following scenario in which we will see the index breaking all-time highs.
This article was written by the ADSS Research Team
