Pound Sterling Recovering Against Euro & Dollar As Inflationary Warnings Sounded by Strong PMI Print

Above: Labour costs in the hospitality industry are a key source of inflation facing businesses reports S%P Global. Image © Adobe Images

The British Pound is recovering against the Euro and Dollar after data showed the economic rebound strengthened in April, as did inflationary pressures facing UK businesses.

The Pound to Euro exchange rate recovered from a multi-week low in the minutes after it was revealed the UK Services PMI rose to 54.9 from 53.1 in April, surpassing expectations for 53.

"UK private sector activity expanded for the sixth consecutive month in April as a robust recovery in service sector output helped to offset a marginal decline in manufacturing production," said S&P Global, producers of the PMI report.

The Pound to Dollar exchange rallied to 1.2387, having been as low as 1.2331 earlier in the day.

"Output growth was supported by a solid upturn in new order volumes and a modest acceleration in staff hiring, in each case driven by the service economy," added S&P Global.

The Pound has been pressured over recent sessions by a rebound in expectations that a number of interest rate cuts will be forthcoming from the Bank of England in the coming months.

Strong economic data can offset some of the recent weakness if it suggests to markets the Bank might have to proceed cautiously when it comes to cutting interest rates. "The PMI suggests the economy is in rude health," says Rob Wood, Chief UK Economist at Pantheon Macroeconomics.

Indeed, the PMI survey reports a steep increase in average cost burdens across the private sector, "with the rate of inflation up sharply from March and the highest since May 2023."

Above: GBP/EUR at five-minute intervals. Track GBP/EUR with your own custom rate alerts. Set Up Here

The Bank of England Governor and Deputy Governor have both said in the past week that UK inflation is well on course to hit the 2.0% target, which will justify lower interest rates.

However, should inflationary pressures start building again, the Bank could consider delaying the first rate cut to August.

These PMI figures suggest caution is warranted by a Bank that is increasingly signalling the battle against inflation has been won. "UK PMIs just added to the collection of data that makes recent comments from Bailey and especially Ramsden look out-of-sync. Long GBPEUR positions look good here," says Simon Harvey, Head of FX Analysis at Monex.

Above: The PMI is a leading indicator of official GDP data. Image courtesy of Pantheon Macroeconomics.

Stronger input price inflation was overwhelmingly linked to higher staff wages, says the report, particularly in the hospitality and leisure sector. It adds that many survey respondents noted pressure on labour costs from a near 10% annual increase in the National Living Wage and an indirect impact on pay awards to other employees.

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence says the improving economic recovery picture is welcome news, but "the upward pressure on inflation will add to concerns that a sustainable path to below target inflation has not yet been achieved."

"UK PMIs underscore strong activity, and output prices continue to decline, even though input prices rose sharply. We maintain our view that the BoE is likely to cut only in August," says George Buckley, an economist at Nomura.

If the market comes around to this view, rate cut expectations can recede a little from here as June is priced out entirely, which could mean the lows for the Pound are at hand.

But Rob Wood, Economist at Pantheon Macroeconomics, says these findings won't provide the weight of evidence required to knock the Bank off its path towards a June cut.

"The timing of the MPC’s first rate cut has become relatively data-independent in our view. Or put another way, the bar to a cut is low. Small data misses and signs of modest extra inflation persistence won’t knock the MPC off course. Accordingly, we continue to expect the MPC to cut Bank Rate in June, then again in September and December. Signs of stubborn services inflation could limit further cuts after that," he says.