Pound Sterling Rises after Construction PMI Rebounds in April but Boost May Prove Short-lived

-Construction PMI Rises faster than expected, to 52.5, April. 

-Draws line under earlier slump that hit first-quarter economic growth.

-GBP rises but Brexit risk and government stability threat still loom large.  

© aallm, Adobe Stock

Pound Sterling rose against its major rivals Wednesday as traders responded to a better-than-expected IHS Markit PMI survey that showed the UK construction industry roaring back to life in April.

The April construction PMI came in at 52.5, up from 47.0 in March and far ahead of the consensus for a more modest rebound to the 50.5 level. 

This marks the fastest increase in five months and was driven by a modest rebound in new orders and strong growth in residential construction activity. 

However, while currency traders and Pound Sterling responded positively to the data, some were left unimpressed and have already projected the rebound will prove to be short-lived.

No sign of catch-up growth in the UK construction sector in April, following heavy snow in March. PMI merely in-line with its 12-month average, consistent with flat output in Q2: pic.twitter.com/zrATg8cvcN

— Samuel Tombs (@samueltombs) May 2, 2018

PMI surveys measure changes in industry activity by asking respondents to rate conditions for employment, production, new orders, prices, deliveries and inventories. A number above the 50.0 level indicates industry expansion while a number below is consistent with contraction.

"Housebuilding remains the stand-out sub-sector," says Samuel Tombs, chief UK economist at Pantheon Macroeconomics. "But the PMIs for the commercial and civil engineering sectors rose only to 51.2 and 51.5 respectively."

Better weather during the April month saw the beleaguered civil engineering and commercial construction subsectors experience a modest improvement in activity, which followed a steep slump in March, but Pantheon's Tombs says this is likely to prove short-lived. 

These areas are both sensitive to changes in public and business investment and are vulnerable to further weakness in the months ahead given the uncertainty around the UK's future relationship with the European Union. 

Notably, these subsectors were also the primary drivers behind a year-long slump in overall construction activity that pushed the industry into recession and hampered first-quarter economic growth in 2018. 

"In addition, the construction sector will be hurt by a planned 5.4% year-over-year reduction in public sector gross investment in this fiscal year. As a result, the odds of the construction sector enjoying a sustained recovery this year still look remote," Tombs adds.

Sterling was quoted 0.27% higher at 1.3642 against the US Dollar following the release, after extending an earlier gain, while the Pound-to-Euro exchange rate reversed an earlier loss to trade 0.11% higher at 1.1359.

BoE Interest Rate Rise Shelved - For Now

Office for National Statistics data showed last week that the construction industry was among the greatest contributors to the poor first quarter GDP data that surprised markets, silenced the last few holdouts who were hoping for an interest rate rise in May and sank Pound Sterling. 

The first quarter GDP number topped off a torrid two weeks that saw the Pound buffeted by slower than expected wage growth for the month of February and a steep fall in March inflation. Both of these events contributed to an about-turn by Bank of England governor Mark Carney on the question of a May interest rate rise. 

As a result, interest rate derivatives markets now imply there is almost zero chance of the BoE raising its interest rate on May 10, which is down from a more than 50% implied probability just two weeks ago. 

Markets are now looking to subsequent BoE meetings over the course of the summer although there is currently little agreement on exactly when the next move might come. 

The market implied Bank Rate for August 02, which coincides with a BoE meeting, is just 0.58%. This suggests only a limited conviction in the market that interest rates will have gone up again by then but the December 20, 2018 implied rate is some 0.71%.

Given the Bank Rate would sit at 0.75% after another hike it is fair to say there is still a fairly strong expectation among traders that the BoE will eventually move again this year. 

Brexit and Government Instability Top the Agenda

"The pound has been under relentless downward pressure. The upturn in Brexit uncertainty surrounding the Customs Union debate is not helping. Today will be an important day in this debate with PM May holding a cabinet meeting to try and reach a consensus on an approach to border controls," says Derek Halpenny, European head of global markets research at MUFG.

The current state of play in Westminster and around the Brexit negotiations has also been hanging over the head of the government, and British currency, like a domocles sword ever since the a key member of the cabinet was forced to resign Monday over an immigration scandal and the House of Lords inflicted a humiliating defeat on the government over its Brexit plans.  

"The government now appears set on a hybrid “customs partnership”. The ‘hard Brexit’ camp call it “bonkers” and unworkable and the FT is reporting that a ‘hard Brexit’ faction of sixty Tory MPs, led by Jacob Rees-Mogg, have written to PM May warning against this move and threatening to pull support," Halpenny adds. 

Negotiators from both sides of the English Channel have been at loggerheads over how to satisfy a joined desire to avoid a "hard border" between the North and Republic of Ireland while delivering UK independence from Brussels and preserving the EU's customs union and so called single market.

Some have suggested the UK should remain within the EU customs union and single market, both key pillars of the EU itself, in order to break the impasse but proponents of Brexit have said this would be unworkable while criticising it as a "betrayal" of the electorate. 

"If PM May sticks to her plan, domestic political uncertainty could escalate quickly. We are still unconvinced by this and as we have previously maintained, the hard fact is that the hard Brexit faction do not have the parliamentary numbers to push through their desired approach," says Halpenny. 

Halpenny and the MUFG team say a "soft Brexit" with some form of customs union membership is the most likely outcome and that this would also be best for the Pound. 

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