GBP Higher on Service PMI, But Major Currency Risks Lurk Ahead

Another strong data release in the UK has ensured the pound sterling has pushed higher on the foreign exchange markets.

Services PMI figures for June read at 58.5, ahead of analyst expectations for 57.4. When combined with the Construction and Manufacturing PMI figures released in previous days the data confirms the UK economy continues to grow at a decent pace and the British pound has been bought accordingly.

We are seeing particularly strong gains against the commodity dollars with the pound over a percent higher against the Australian dollar. The pound v euro rate is meanwhile static – the impending Greek referendum on Sunday will ensure no one is willing to push the envelope on this currency pair.

The pound has also arrested its recent declines against the US dollar with a poor US NFP figure halting the broad-based USD strength seen at the start of July.

The Services PMI data reading confirms a post-election rebound in activity, and meant that the second quarter of 2015 was the strongest on average since Q3 2014.

However, there were some worrying developments with a slowdown in new order growth resulting in spare capacity at UK service providers.

This was signalled via the first monthly reduction in work outstanding since March 2013. Anecdotal evidence linked the decline to uncertainty in core sales markets.

Should spare capacity start growing the Bank of England may hold back on the timing of their first interest rate rise of the upcoming cycle of hikes.

Currency markets are currently driven by interest rate policy at global central banks with the general rule being that rising rates result in rising exchange rates.

Furthermore, developments in the Eurozone continue to keep the sector restrained. David Noble, Group Chief Executive Officer at the Chartered Institute of Procurement & Supply who deliver the PMI series in conjunction with Markit says:

“There was also sufficient confidence to develop new products and opportunities, though a slowdown in key markets in the Eurozone contributed to some hesitancy in job creation, which, though still strong, was at its slowest pace for six months.”

The Currency Outlook: Bumps Ahead

Watch the Greek referendum and subsequent developments.

Polling suggests the Yes outcome will hold sway, the reaction of the current government will be key to the currency response.

“Our biggest concern initially was that even on a 'Yes' vote, the Syriza government might have been unwilling to step down. Comments this week seem to confirm Tsipris and Varoufakis would resign, which should limit that risk. Now, the biggest political questions we face centre on the post-referendum landscape,” says Richard Kelly at TD Securities.

Specifically, will Syriza agree to work in a national unity government or does the party split along ideological lines? 

There, some faction might agree to work with one or more alternatives (New Democracy, PASOK, or To Potami).

“Ultimately, this could produce a more stable—and therefore positive—outcome. If Syriza remains intact and refuses to participate with a unity government, however, we expect a much more difficult road ahead,” says Kelly.

So while the outcome of the referendum will certainly be important to the euro, the resultant reactions will be the ultimate movers.

Elsewhere, as mentioned, commodity currencies remain under pressure (AUD, NZD, CAD).

With retail sales in Australia this morning coming out weaker than expected and a new slump in iron ore prices, the GBPAUD has gained ground from 2.04 to above 2.08.

We are also watching oil prices, which are putting pressure on range supports, which if broken should see the CAD extend recent losses.