UK Manufacturing and Industrial Data Disappoints but Economy is on Road to Recovery

-UK manufacturing and industrial sector output falls in May.

-Construction extends gains, drawing line under prior slump.

-UK economy to recover in second-quarter say economists.

© Winterbilder, Adobe Stock

The Pound pared some of its gains Tuesday after Office for National Statistics data showed the UK manufacturing and industrial sectors growing slower than was expected during the month of May, tempering expectations for a sharp rebound in GDP growth during the second-quarter. 

UK manufacturing production rose by 0.4% during the May which, although up from the -1.4% contraction seen previously, was below the consensus forecast for growth of 1%. This contributed to a poorer than expected result for the broader industrial sector, which includes construction and energy industries alongside manufacturing.

Industrial production fell by -0.4% during May, deepening the -0.8% contraction seen back in April, which was below the consensus forecast for growth of 0.5%. However, and on a brighter note, the once-beleaguered construction industry staged a notable comeback during the month.

Construction output rose by 2.9% in May, up from 0.55 previously, when economists had been looking for grwoth of just 0.4%. The construction sector fell into recession back in 2017 and was a notable contributor to the sharp slowdown in UK growth during the first quarter, so the rebound may come as welcome relief for some.

"The modest 0.4% increase in manufacturing output, following a cumulative 1.8% decline over the previous three months, was disappointingly weak, but surveys still are consistent with fairly healthy growth ahead. Overall, today’s report should leave the MPC confident that quarter-on-quarter GDP growth likely will rise to 0.4% in Q2, matching its forecast," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

The Pound was quoted 0.06% higher at 1.3246 against the Dollar following the release while the Pound-to-Euro exchange rate was 0.22% higher at 1.1298.

Manufacturing has been a relative bright spot for the UK economy ever since the Brexit vote of June 2016, with the double digit fall in the Pound making British goods cheaper for overseas customers to buy, while a robust domestic economy has also fuelled demand.

This saw industrial firms experience eight consecutive quarters of output growth in the period to the end of 2017, marking the longest expansion for the sector since 1988, although momentum has waned recently. The latest slide in activity will add to fears that this Brexit-boost to the sector is now over.

"We still have concerns, however, that the economy will struggle to maintain Q2’s growth rate in the second half of this year. Spending in the retail and consumer services sectors in Q2 has benefited from warmer-than-usual weather," adds Tombs. "Consumers’ confidence still has not recovered and increases in energy prices will drive CPI inflation back up again during Q3. Meanwhile, high political uncertainty means businesses likely will remain reluctant to invest."

Markets care about the data because manufacturing is Britain's third largest economic sector and so production numbers here can have an impact on overall expectations for GDP growth.

GDP growth is important because it reflects rising and falling demand within the economy, which has a direct bearing on consumer price inflation which is itself important for questions around interest rates. And interest rates themselves are a raison d'être for most moves in exchange rates.

Tuesday's numbers come closely on the heels of IHS Markit PMI data showing the UK manufacturing, construction and services industries finishing the second quarter in good form. This left economists looking to the second-quarter GDP numbers for signs of a solid economic recovery after a first-quarter slump.

UK GDP growth slowed to 0.2% during the first quarter, from 0.4% at the end of 2017, after a seasonal slowdown and two weeks of inclement weather hit activity during the period. However, since then, inflation has fallen faster than expected and retail spending has shown signs of picking up from its post-referendum lull.

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Politics in Focus

Tuesday's data also comes at a time of unease for Pound Sterling and UK politics that has seen Prime Minister Theresa May abandoned by the leading Brexit-supporting MPs within her own party following a policy u-turn in which the PM backpedalled on earlier commitments to deliver a complete break with the European Union.

"There remains one crucial positive factor beyond all of this though. This fact has existed since the general election over a year ago that the parliamentary numbers are more in favour of a softer version of Brexit, which greatly inhibits the potential action the hard Brexit faction can take," says Derek Halpenny, European head of global markets research at MUFG.

Foreign Secretary Boris Johson and Brexit Secretary David Davis both resigned from office Monday after PM May adopted a Brexit plan that, from the very beginning, will see the UK remain within the EU single market and customs union for goods trade.

This means remaining under the auspices of the European Court of Justice and could see the government forced to accept the continued free movement of labour under a different name. All of these issues have been so called "red lines" for the PM and governing Conservative Party ever since the referendum.

Fears were the about turn could see a challenge to PM May's leadership although the balance of leave and remain supporting MPs in the Conservative parliamentary party is seen as assuring the PM's place in office potentially as far as the next election, regardless of what she does with Brexit.

"While May’s leadership capacity remains a ‘watch this space’ – one thing political analysts note is that a vote of no confidence in the PM can only be called once over a 12 month period. Therefore we suspect the risk of an imminent leadership challenge may be smaller than initially thought yesterday – with Tory rebels unlikely to waste their one shot at a time when there is no credible leadership alternative to PM May," says Viraj Patel, an FX strategist at ING Group.

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Bank of England to Raise Rates?

The first-quarter economic slowdown, and a steep decline in UK inflation, already led the Bank of England to abandon the idea of an interest rate rise in May. This dented the Pound and left markets looking to the August meeting for the next possible move.

"I would have voted to raise Bank Rate at the MPC’s May meeting had data on the economy held firm. What we saw ahead of that meeting was a string of weak data suggesting consumer spending might be faltering," says Andy Haldane, chief economist at the BoE and a member of the Monetary Policy Committee (MPC), in a June speech. "I believed there was option value in waiting to see if these data signalled the start of a lasting retrenchment by households, or were instead a temporary snow or statistical blip."

Haldane was one of three MPC members to have voted in June for an increase in the UK's main interest rate, after eschewing such a decision in May. Many economists now expect the Bank of England will go ahead and raise rates in August, although financial markets have been slow to take note.

Sterling-Overnight-Index-Average pricing on the morning of Tuesday 10, July implied and August 02 Bank Rate of 0.62%. If markets were as confident in the likelihood of an August rate rise as Andy Haldane appears to be in the merits of one then that implied rate would be closer to the 0.75% the actual Bank Rate will sit at the next time the BoE pulls the trigger.

If and when financial markets become more willing to bet on an August interest rate rise then this implied rate will rise further, and the Pound with it.

"GBP has been temporarily saved from a further sell-off as it emerged late yesterday that no leadership challenge had been mounted against May. The biggest risk to GBP now is a one-off dovish BoE re-pricing in markets; prior to yesterday’s events, the UK OIS curve had been pricing in a 79% probability of an August rate hike – and today’s new monthly UK GDP data release should support a hike," says Chris Turner, global head of FX strategy at ING Group.

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