Daily Market Update: Sharp drop in UK PMIs underscores the downside risks facing the UK economy and sterling
Friday’s one-off UK flash PMI results for July showed the UK economy is weakening by materially more than analysts had been expecting.
The composite PMI (a measure of underlying private sector activity growth) fell from 52.4 to 47.7 in July, the biggest decline in the series 18+ year history. This was driven primarily by a steeper than expected fall in the services PMI, from 52.3 to 47.4, with significant weakening present in both new business and future business expectations. While manufacturing held up slightly better than expected (helped by slight improvement in new export orders), it still slipped from 52.1 to 49.1 – its weakest level since 2013. Analysing the relationship between the composite PMI and quarter-on-quarter GDP growth over the past 10 years suggests that a reading of this level is consistent with GDP contraction of 0.6% q/q. Although we need to be wary that this is just a single month’s reading (and like with all flash PMIs, includes just ca. 70% of the usual participants), a decline anywhere near this magnitude is materially worse than would be consistent with the latest consensus UK growth forecasts, meaning that further reductions are likely in the pipeline for growth projections (which had already been scaled back to adjust for Brexit-related effects). This implies the likelihood of further downside to come for UK market interest rates and sterling, while the deterioration in the outlook also strengthens what was already a pretty robust case for additional stimulus measures from the Bank of England at their next policy meeting (which is just 10 days away).
In contrast to the weakness in the UK PMIs, Friday’s flash PMI from Markit covering the US manufacturing sector’s performance in July was stronger than expected. The headline index rose for the second month running, from 51.3 in June to 52.9 – its highest level since October last year. Note that the more closely followed ISM index has been trending higher for several months now too. So we take these recent indications of a pickup in growth momentum as an encouraging sign that US manufacturing is experiencing a notable improvement in growth dynamics, following a difficult period in which the sector had been buffeted by several headwinds including softer global growth, a stronger dollar and a collapse in oil prices. The firmer US data has re-focussed attention on the theme of US economic outperformance relative to Europe at present, with Friday’s Composite PMI from the euro area consistent with slowing growth momentum into the early part of Q3 in the zone (though it held up slightly better than expected). And in turn, US growth outperformance is helping to underpin dollar outperformance on the exchanges, with the weak UK PMIs meaning that sterling underperformance is also a notable theme. The greenback is up about 0.6% against the euro since early Friday to open at $1.0960 in early trading, and is posting larger gains of 0.9% against the pound which came under renewed pressure following the weak PMIs. GBP/USD opens at $1.3125, while Eur/GBP is about 0.3% higher than it was early on Friday, and kicks off the week’s trading at 83.55p.