Exiting Recession: Pound Sterling Supported Against Euro and Dollar Following PMI Data Release

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The UK economy appears to have extended its early-2024 recovery through February, with a much-watched survey of the economy reporting "a solid rate of service sector growth".

The British Pound extends its weekly advance against the Dollar and remains supported in the upper 1.16s against the Euro after S&P Global reported the UK's composite PMI rose to 53.3 in February from 52.9 in January.

This beats the consensus expectation for 52.9 and brings further evidence that the economy has likely exited the shallow recession of the second half of 2023.

The Pound to Euro exchange rate was steady at 1.1982 in the wake of the data, having earlier climbed as high as 1.1692 following the release of German manufacturing PMI data showing a worrying deterioration in activity in Europe's largest economy. Euro weakness was limited by the Eurozone PMI release that showed an improvement in activity elsewhere in the Eurozone.

Similar to Germany, the UK's manufacturing sector also continues to struggle, albeit to a lesser extent, with the UK manufacturing PMI reading at 47.1, up from 47 in January but undershooting expectations for 47.5.

But because the UK is predominantly a services economy, it was always the services PMI that would carry the day. Here, a reading of 54.3, unchanged from January but higher than the 54.1 expected, will offer some optimism.

The Pound to Dollar exchange rate extended its weekly gain to 1.2686, a move that is predominantly a function of broader USD weakness that follows a potential peaking in the hawkish repricing of Federal Reserve interest rate expectations that has dominated 2024.

Above: The UK economy returned to growth in Q1, bringing an end to the recession. Image: S&P Global.

According to S&P Global, a solid rate of service sector growth helped to boost UK private sector output in February, ensuring business activity across the UK private sector expanded for the fourth consecutive month and at the fastest pace since May 2023.

"This is by no means a one-off improvement, as faster growth has now been recorded for four straight months after a brief spell of decline late last year," says Chris Williamson, Chief Business Economist at S&P Global Market Intelligence.

S&P Global estimates their findings mean the economy is likely growing at a quarterly rate of 0.2-0.3% in the first quarter of 2024. This would mean the recession of H2 2023 is already over.

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Williamson says he is particularly encouraged by an upturn in growth has been accompanied by a surge in optimism about year-ahead prospects to the highest for two years.

The data suggests there is no imminent need for the Bank of England to cut interest rates, particularly given the PMI report's findings that February saw the highest degree of supply chain delays for over one and a half years, linked to Red Sea shipping disruptions.

This proves inflationary as the resulting increased shipping costs contributed to the largest monthly rise in selling prices for goods seen over the past nine months.

"Service sector inflation also ticked higher, remaining stubbornly elevated thanks to higher wage costs and the pass-through of some higher goods prices. The survey data signal consumer price inflation running around the 4% level in the coming months – double the Bank of England's target," says Williamson.

The market is fully priced for the first rate cut from the Bank of England to come in June, but this might prove optimistic if inflation does indeed track at 4.0% over the coming months. The Pound will likely remain supported under such a scenario.

"I still think sub-2% headline inflation from April enables a June rate cut, but it's far from a done deal," says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.

The Bank of England and most forecasters say UK inflation will hit 2.0%, or below, in April as a sizeable cut to household energy bills occurs.

But, the Bank says inflation should drift up from here over the remainder of the year. The pace and extent of this 'melt-up' will be the story of 2024 when it comes to UK financial markets and the Pound.