Another Blow for GBP as Services PMI Undershoots

The final of the three Markit PMI releases for January has disappointed markets and the pound sterling exchange rate complex (GBP) is being sold in response.

After witnessing its best level in years the pound to euro exchange rate has slumped back into the mid 1.27 region while the pound dollar rate is into the 1.51's.

Momentum has now turned firmly against the UK currency and sets the scene for a tough January.

Those with currency requirements funded in GBP should be aware that softer levels could well be on the cards.

Services PMI Comes in Below par

The January Markit/CIPS Services PMI came in at 55.8, currency traders were priced for a reading of 58.5 - the miss on expectations has seen selling as markets re-adjust.

The miss on services reflects similar disappointments, firstly on the manufacturing and then construction sectors.

The UK services economy experienced a loss of growth momentum at the end of 2014, with both activity and new business rising at their weakest rates in over a year-and-a-half.

The crux for sterling exchange rates lies in the following statement issued by Chris Williamson, Chief Economist at Markit:

“The survey data provide policymakers with a mixed bag of news on the health of the economy at the end of last year, adding further uncertainty about the outlook for interest rates."

The softer readings are telling markets that the Bank of England policy makers will be happy to sit on the sidelines when it comes to raising rates.

As long as UK interest rates remain 'lower for longer' the financial system will fail to attract capital inflows that seek to take advantage of higher yield and demand for sterling will remain supressed.

But, Beware

As we know exchange rates are incredibly tough to call and there is the danger that markets are missing the bigger message hidden in today's data.

Markit tell us:

• despite the slowdown, growth rates remain well above historical averages
• supporting the latest increase in activity was a further rise in volumes of new business
• backlogs of work rising for a twenty-first month in a row
• insufficient staff numbers were also reported as a factor underpinning backlog growth
• extra workers were taken on in line with positive forecasts for company performance in 2015

There is no doubt the UK economy continues to grow at a clip and, crucially for the pound to euro pair, this growth remains superior to the struggling Eurozone.

The BoE rate setters could well be looking through the short-term noise and looking at the longer-term trends.

If so, then sterling will enjoy upside when markets readjust for a mid-2015 interest rate hike.

Euro Strength to be Limited

Despite the current softening in the GBP/EUR we would suggest euro gains will likely be short-lived.

"European equities, currencies and ‘peripheral’ sovereign bonds sold off sharply (Stoxx 50 down 3%), as markets weighed the prospect of ECB QE against ongoing concerns about deflation, growth and the forthcoming Greek election," says Dennis Tan at Barclays in reference to the euro's outlook.

US equity markets also sold off in sympathy with Europe, while US Treasuries and the JPY rallied on the pick up in risk aversion.

EURUSD fell below 1.20 to its lowest level in almost nine years following Draghi’s comments regarding the risk of deflation and the increased likelihood of ECB QE.

"Political uncertainty is on the rise as Greek political parties begin an election campaign, although German Chancellor Angela Merkel's spokesman downplayed her weekend comments on “Grexit” by reiterating that the official stance had always been to stabilize the Eurozone without losing any of its members," says Tan.

Lower than expected German CPI also weighed on the EUR. Meanwhile, crude prices continue to slide, with Brent falling more than 6% to $53/b. Oil-related currencies like RUB, COP, MYR and NOK underperformed.