British Pound Receives Additional Support from Construction Sector Recovery as Markets Eye Brexit Deal

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- U.K. construction PMI surprise helps to support GBP Friday.

- Recovery led by civil engineering pick up, outlook improves.

- Follows hawkish BoE message, reports of Brexit breakthrough.

The Pound was supported Friday by IHS Markit PMI data showing activity in the construction industry picking up sharply in October, providing a tailwind to the British currency, which had already been boosted by speculation suggesting a Brexit deal is almost done.

October's IHS Markit construction PMI came in at 53.2, up from 52.1 back in September and in contrast to the market consensus for a decline to 52.0.

Activity rose at its second-fastest pace for 16 months as demand for civil engineering services picked up following a poor summer period. 

However, and on the downside, growth in housebuilding and commercial construction activity cooled during October, following a months-long period where momentum appeared to be building. 

"The modest increase in the PMI in October, to its second-highest level in the last 16 months, provides reassurance that the construction sector still has its head above water," says Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics. "On past form, the PMI is consistent with quarter-on-quarter growth in construction output of about 0.2%. Activity, however, looks set to deteriorate over the coming months."

PMI surveys measure changes in industry activity by asking respondents to rate conditions for employment, production, new orders, prices, deliveries and inventories. A number above the 50.0 level indicates industry expansion while a number below is consistent with contraction.

Markets care about the PMI data because they are an important indicator of momentum within the economy. And economic growth has direct bearing on the rate of inflation and it is consumer price pressures that dictate where interest rates, which are the raison d'être for most moves in exchange rates, will go next.

The Pound was quoted 0.20% higherat 1.3028 against the U.S. Dollar following the release and has risen close to 2% this week alone. The Pound-to-Euro rate was 0.09% lower at 1.1391 and is up 1.3% this week. 

"The construction sector has the potential to enjoy a solid recovery when business confidence revives. Note too that the Budget incorporated plans for a hefty 10.4% increase in public sector gross investment in 2019/20," says Tombs. "But builders will have to endure a tough Q4 and Q1 first, as firms hold back from making investments until Britain’s Brexit path is known."

Friday's data comes after the October manufacturing PMI fell to its lowest level since the Brexit vote, after tensions over international trade and uncertainty about the U.K.'s future relationship with the EU hampered activity in the sector.

But it also follows October's monetary policy update from the Bank of England (BoE), in which policy makers made clear the BoE intends to raise interest rates next year regardless of what happens with the Brexit negotiations. 

Whichever way Bank of England officials look, they see inflation pressures mounting, whether it comes from a politics-driven fall in the value of the Pound, rising oil prices or mounting wage bills for companies. 

This provided the British currency with a tailwind Thursday, enabling it to build on gains wracked up after it emerged that officials from the U.K. and European Union may be close to agreeing terms of the U.K.'s withdrawal from the EU. 

However, the U.K. economy is on course to expand by around 1.3% for the 2018 year, a much lesser rate than the 1.7% seen in 2017, due to a steep weather-induced slowdown in the first quarter.

Office for Budget Responsibility (OBR) forecasts released Tuesday suggest the economy is likely to expand by 1.6% in 2019 but that growth will slow to just 1.4% in 2020 and 2021.

Business investment growth remains lacklustre while international trade is assumed to make no contribution to growth over coming years given the OBR expects a reduction in "trade intensity" after Brexit day in March 2019.

Despite forecasts of weakening growth, markets are anticipating that the Bank of England (BoE) will continue raising its interest rate over coming years, and potentially on two occassions inside of 2019. 

Changes in interest rates are only normally made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

U.K. inflation fell back to 2.4% during September, after having risen briefly back to the 2.7% level. It has declined from 3.1% in January 2018 but the Bank of England says its forecasts suggest the consumer price index will remain above the 2% target over coming years unless it continues to raise interest rates. 

The BoE hiked the Bank Rate by 25 basis points, to 0.75%, back in August. That followed another rate hike back in November 2017, the bank's first since the financial crisis. 

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