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Pound Exchange Rate Sinks Despite Services Pick-Up; Carney Creates Headlines

September 5, 2018 12:04 pm | Modified September 5, 2018 12:05 pm
Brexit, Central Banks, GBP | BY Charlie Murray

This morning the Pound exchange rate has fallen against the Euro (GBP/EUR), US Dollar (GBP/USD) and other majors across the board, despite an upswing in UK service sector data.

The Pound’s had a tough start to the week; yesterday, the UK’s Markit/CIPS Construction Purchasing Managers’ Index (PMI) proved that July’s stellar 14-month high was an outlier, caused by the sector playing catch-up from weather dampened activity at the start of 2018. Construction still recorded reasonable growth in August, however, albeit more moderate.

UK Construction Falls as Brexit Bites

Yesterday’s Construction PMI reiterated a sentiment in Monday’s Manufacturing PMI: Brexit uncertainty is holding back investment spending. Investment accounts for only 17% of UK GDP. The limited contribution of investment to UK output caught many economists off-guard in the immediate aftermath of the Brexit referendum. The Brexit uncertainty inspired decline in investment was not enough to plunge the UK into recession in the aftermath of the vote. It will, however, damage the economy’s long-term potential, holding all other factors constant. It is the counterfactual that economists can forecast but they cannot know the UK’s lost economic potential.

Will Carney Stay or Will He Go? BoE Chief Opens up Possibilities

The Bank of England’s (BoE) Treasury Committee testimonial proved market-moving and not just for the particulars on Governor Carney’s employment contract. In the event of an economic crisis, the modern central bank faces a predicament: cut interest rates to reduce unemployment and accept higher inflation, or, let unemployment rise and keep inflation unchanged. It is the difference between everyone collectively being a little less well-off and some people having nothing.

Asked about the Bank’s policy response in the event of a no deal Brexit, in which inflation is likely to automatically increase, Carney suggested he could choose option two. The Governor recognised the squeeze on real incomes over the last decade and noted that it was ‘easy to see a scenario in which policy should be tighter, not looser’.

Dissatisfied lower-income voters, who have grown considerably in number, was one of the key themes in the Brexit referendum. Carney, it seems, has taken note and is no longer willing to overlook the political and social consequences of low real wage growth. On Carney’s comments, the UK rates market increased the implied probability of a rate hike, though only marginally, providing short-lived support to the Pound exchange rate.

In the afternoon session, the US ISM Manufacturing release set the tone ahead of Friday’s Nonfarm payrolls and sent the US Dollar shooting higher against most of the majors. The barometer of US manufacturing surged to a 14-year high, with the employment index rising to 58.5. Combined with the Conference Board Index, the indicator suggests a Non-farm number close to 200K. The strength of the ISM index also suggests little negative impact from Trump’s protectionist push with new export orders falling only marginally to 55.2 to 55.3.

Pound Exchange Rate Falls as UK Service Sector Improves, but Staffing Issues in the Spotlight

For the day ahead, UK Services and Composite PMI will end the suite of UK PMI releases. Services makes up three-quarters of UK output and is therefore the final and most important PMI reading. The ecostat printed at 54.3 in August, an increase on July’s 53.5. July’s softened pace of expansion showed some signs of Brexit uncertainty biting, with reports of delayed projects and investments, while the August report showed firms were finding it difficult to find the staff they need.

Markit commented: ‘Backlogs of work increased for the fourth month running in August, which pointed to sustained pressure on operating capacity at service sector companies. A number of firms linked rising volumes of unfinished business to difficulties replacing departing staff.’

In the afternoon, the July US Trade Balance release will be in President Trump’s line of sight and is therefore important for the developing trade war. Fed’s Kashkari, labelled a dove due to his concern over yield curve inversion, speaks. Canada’s merchandise trade balance and central bank rate decision are scheduled for the afternoon session. The Bank of Canada is expected to hold policy unchanged.

The Pound to Euro (GBP/EUR) exchange rate is trending in the region of 1.1067, while the Pound to US Dollar (GBP/USD) exchange rate is trading at 1.2822.


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