British Pound Drops as UK Services PMI Heralds Economic Slowdown

Above: The services sector employs the majority of the UK workforce and accounts for more than 80% of UK economic activity.

Pound Sterling slipped against its major rivals ahead of the weekend on the back of another set of disappointing economic data out of the UK economy.

The release of February's service sector PMI data from IHS Markit and the CIPS came in below analyst expectations in a sign the UK economy is slowing down at a faster-than-anticipated rate.

Service PMI for February read at 53.3, below analyst expectations for a reading of 54.1 and well below the previous month's 54.5.

This represents a five-month low for the series extending a disappointing run for UK data thus far in 2017 with the February release of January’s services PMI data having a negative impact on Pound Sterling.

We noted at the time that the UK currency was finally starting to take cues from events other than Brexit with a focus on economic data and the intentions of the Bank of England growing in importance.

Today's reaction by the Pound to the data is similar in nature and confirms the currency to be sensitive to the economic data pulse once more:

The Pound to Euro exchange rate is at 1.1584, down 0.70% on the day's open.

The Pound to Dollar exchange rate is at 1.2234, down 0.3%.

"None of this news was welcomed by the Pound. Cable saw its losses increase to 0.3%, digging Sterling deeper into its 6 week low against the greenback, while against the Euro the Pound plunged by 0.7%, pushing it to its worst price in nearly a month," says Connor Campbell, an analyst with Spreadex in London.

The Pound therefore retains a weak undertone.

With regards to the GBP/USD, a loss of support at 1.2265 points to additional losses to the mid 1.21 area argues analyst Shaun Osborne at Scotiabank.

Osborne notes trend signals are aligned bearishly across a range of time frames, which should limit upside scope for the GBP to the mid/upper 1.22 area now.

"We expect continue expect the GBP to extend its current retracement back to the Jan low (1.1993) in the next few weeks. Sell minor GBP rallies," says Osborne.

UK GDP Growth Slowing

February’s Markit/CIPS services survey adds to other evidence that suggests that the economy has lost a bit of momentum in the first quarter.

The fall in the headline activity index from 54.5 in January to 53.3 was bigger than the consensus expectation of a drop to 54.1 and took the index to a five-month low.

"Note too that the services survey does not include the retail sector, which appears to have begun the year on a soft footing," says Paul Hollingsworth, UK Economist at Capital Economics.

Hollingsworth does note that the future activity index only ticked down from 70.8 to 70.5, above its long-run average and suggesting that firms are not especially pessimistic about the near-term outlook.

Taken together with February’s manufacturing and construction surveys Capital Economics believe the economy-wide all-sector PMI fell to a level consistent, on the basis of past form, with quarterly GDP growth of about 0.4%.

While this is slower than Q4’s 0.7% rate, Hollingsworth believes it is nonetheless still respectable.

"Looking ahead, the economy faces a number of headwinds including higher inflation and uncertainty surrounding the future relationship with the EU as formal negotiations get underway. However, we continue to think that the UK will weather these well, and expect GDP growth of 1.8% in 2017 and 2.5% in 2018," says Hollingsworth.

Analyst Daniel Vernazza at UniCredit Research in London forecasts quarterly economic growth to be at 0.3% in the first quarter and cites two salient explanations for the recent softness in economic activity:

"First, the squeeze in real household income growth (resulting from higher imported inflation) is weighing on demand, particularly for retail services. The PMI services input prices balance rose 1.4pts. to 66.4 in February, well above its long-run average of 57.5, and the output prices balance increased 0.3pts. to 54.1 (well-above its historical average of 51.6). It fits with the quite sharp fall in retail sales recently (both from hard data and surveys).

"Second, Brexit-related economic uncertainty remains high and this will increasingly weigh on business investment as the date when the UK formally leaves the EU (spring 2019) approaches."

UniCredit say the sectorial breakdown clearly reveals that the weakness in the UK economy is domestic, with the export-oriented manufacturing sector performing relatively well and supported by the past depreciation of Sterling and firming global economic activity (particularly in Europe).