Daily Market Update: Sterling makes modest gains as UK factory output stages early‐year pick‐up
Yesterday’s official production data revealed a better than expected performance from the UK manufacturing sector in January.
Factory sector output jumped by 0.7% m/m - an outcome that was well ahead of City forecasts for a much more modest 0.2% rise, in the process breaking a three-month sequence of monthly declines. This leaves January manufacturing output running some 0.3% ahead of where it was on average in Q4, thus potentially on track to make a positive contribution to current-quarter GDP growth following a stagnant final quarter last year. These are encouraging developments for sure, and recent sterling weakness should also help future UK manufacturing performance (depending on the extent to which that weakness persists of course).
Nevertheless, there are several reasons to be cautious about taking an overly positive view of yesterday’s figures. First, the manufacturing PMI survey weakened notably in February, casting some doubt over whether the improvement in the official numbers for January will be sustained. Second, the broad measure of overall industrial production (which also includes activity related to oil & gas, utilities and mining & quarrying) was actually a bit weaker than expected, in rising by 0.3%m/m rather than the 0.4% expected. This leaves overall production running 0.8% below its Q4 average level, thus struggling to avoid a second consecutive quarter in which it is a drag on overall GDP growth.
Indeed, yesterday’s unofficial monthly GDP estimate produced by the NIESR in the UK showed some further slippage in overall growth momentum. UK GDP growth over the three months to February is estimated at 0.3%, the weakest reading in three years and down from its January estimate of 0.4% and from the official figure for Q4 of 0.5%. More generally on the UK outlook, we are also becoming a bit more concerned about momentum in the UK services sector following the large decline in the services PMI last week which in part looks to have been related to Brexit uncertainty effects. So while we are encouraged by the positive start to the new year for UK manufacturing, we remain cautious on the near-term outlook for the UK economy.
In a(nother) quiet day for economic news in the US, the only release of any note was a 0.3% rise in wholesale inventories in February. This level of stock-building was larger than the expected 0.2% drop, though the secondary nature of this release did little to alter expectations for first quarter GDP growth. Analysts are now generally expecting Q1 GDP growth to pick up to a 2-2.5% annualised pace, from the somewhat softer than expected 1% pace recorded in the final quarter. With GDP growth on track to pick up to a slightly above-trend rate, the unemployment rate running lower than the Fed had expected, and with core inflation picking up faster than expected, we continue to think that markets are taking an overly benign view of the US interest rate outlook (only one hike is priced in for the entirety of this year).
Thus, we continue to favour a bullish view on the dollar linked to the expectation that a dollar-positive adjustment in US rate expectations is likely to take hold in the months ahead. In the meantime, Eur/USD is little changed over the past 24 hours or so at $1.0970. Helped by the better production numbers, sterling is about 0.2-0.3% firmer against both the dollar and the euro, opening at $1.4225 and 77.1p respectively.
Turning to the session ahead, the ECB makes its much-anticipated March policy announcement today. Wholesale energy price declines alongside both increased downside risks to the global outlook and the crystallisation of some of these risks to a degree means the question is not whether the ECB increases stimulus but rather the extent and form that this extra stimulus takes. Market expectations are for a 10- 15bps cut to the deposit rate (from its current level of -0.3%). There will also be attention on whether the ECB decides to expand the run rate of its quantitative easing programme from the current level of €60bn worth of assets per month.
Additionally, a possible decision to extend the quantitative easing programme beyond March 2017 may be in play (although the ECB has made it clear that it is willing to continue the programme for as long as necessary). With significant easing already priced into markets, the challenge for the ECB will be to exceed market expectations in order to generate any fresh market impact. We think the ECB will be keen to avoid a replay of December’s disappointment, but we are mindful of the risk of that happening once again in which case there could be some upside movement in Eurozone market interest rates and the euro.
In the US, initial jobless claims are released and are expected to come in at 275k, a reasonably healthy number, albeit not quite as strong as the February average of 270k.
Also released today are the Republic of Ireland’s Quarterly National Accounts (which include the GDP figures) for Q4 2015. GDP grew 7.0% in the first 3 quarters of 2015 compared to the same period in 2014. With more timely data (most notably the composite PMI) remaining robust into the fourth quarter of last year, we expect the full-year figures to show growth of around 6.5-7.0% which would binternete a truly exceptional year of growth. Keep an eye out on our twitter feed (https://twitter.com/UB_Economics?lang=en-gb) for updates after the figures are released at 11.00 this morning.