GBP Bounces as Manufacturing PMI Beats Expectations

The British pound was in demand on the first day of 2016 after it was reported UK manufacturers continue to expand their business.

The UK’s manufacturing sector has been a thorn in the side of pound sterling over recent months with concerns that a global economic slowdown was starting to bite.

While manufacturing makes up a relatively small percentage of the UK’s economic composition (the gargantuan services sector accounts for nearly 80% of the economy) the slowdown was feeding into negative debate concerning sterling.

January’s Manufacturing PMI data suggests concerns could be overdone though. Market and the CIPS reported that 52.9 was recorded - well above the 50 needed to signify growth. Markets were expecting a reading of 51.8.

The pound to euro exchange rate was 0.2% higher at 1.3174 in the wake of the release while the pound to dollar exchange rate has moved firmly higher to 1.4359.

We are meanwhile seeing sterling record gains against the commodity currencies in excess of 0.5% with GBP/ZAR up by 1.53%.

But, Digging Deeper, We Find Concerns

"We note in this print that the more general trend of larger firm sentiment being above that of SME sentiment continues. Despite today’s positive headline and output index, we remain cautious on manufacturing in light of a lack of broad-based continued improvement across subcategories," says Andrzej Szczepaniak at Barclays.

Some companies have reported that the GBP to EUR exchange rate remains too strong. The Markit/CIPS report states:

"Companies linked lower overseas sales to stronger competition and tough market conditions. Some firms  also noted that, despite recent easing, sterling-euro exchange rate remained an issue impacting on trade flows with the eurozone."

We see little reason to complain though - the average GBP/EUR exchange rate since 1990 is 1.3641 - we are actually at a long-term equilibrium against the euro. (Long-term euro charts are based on a combination of the euro and the old German Mark).

Either way, it appears that growth is being driven by domestic demand with the report suggesting:

“Manufacturing  production increased again during January, reflecting improved inflows of new work from the domestic market. Moreover, the rate of expansion in output accelerated to a 19-month high.  The trend in new export orders, however, fell back into decline.”

Underlying data is interesting as firms report they have been cutting down on staffing levels. Although the rate of decline in staff head counts was only moderate, it was nonetheless the fastest for almost three years.

Companies linked job cuts to redundancies, retirements, restructuring initiatives, efficiency improvements and efforts to control costs. The Bank of England could be interested in hearing this as it suggests spare capacity in the economy is no longer falling away. The Bank has long pointed to spare capacity as being a driver behind their decision to keep interest rates at record lows.

Also worrying is that the low inflation environment is placing downward pressure on prices.

“Strong competition on the sales side combined with the ongoing weakness of global commodity prices  meant that manufacturers saw selling prices and input costs fall further in January,” says Rob Dobson, Senior Economist at Markit.

It is for reasons like this that the Bank of England is concerned about low levels of inflation and will unlikely raise rates until inflation starts rising again.   

Watch Thursday’s Inflation Report for the latest inflation projections from the Bank; the event forms the single most important event for sterling this month.

Also watch the release of the Services PMI on Wednesday.

"As the manufacturing sector accounts for only around 10% of UK economic activity, the UK’s growth outlook hinges more on developments in the dominant services sector. Today’s release of stronger-than-expected lending data for December points to the key support being derived by households from looser credit conditions, and continues to highlight the unbalanced nature of UK’s growth," says a note from Lloyds Bank.