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Sterling resists weak PMIs to move off multi-year lows

Sterling took advantage of a relatively quiet week for UK data to move off multi-year lows against major currencies such as the dollar, yen and the euro. Investors appeared little concerned from disappointing Markit PMI data, which pointed to slowing growth in February. All three PMI surveys – manufacturing, construction and services – came in below expectations for the month of February, raising doubts about the strength of the UK economy.

Manufacturing PMI, which was the first to be released on Tuesday, fell to 50.8 in February from 52.9 in January, missing estimates of 52.2. The reading was just above expansion territory and the lowest since April 2013. New business and export orders both declined during the month on weak domestic and foreign demand.

The poor performance of the manufacturing sector shouldn’t come as too much of a surprise though given the deteriorating global trade outlook. But the decline in both the construction and services PMIs could be cause for concern for the UK economy, especially for services, which is the dominant component of GDP.

Construction PMI out on Wednesday declined for the second straight month to 54.2 from 55.0 the prior month, missing forecasts of 55.5. The reading remains firmly above 50 but it was the weakest level of activity since April 2015 as residential construction work declined to the lowest since June 2013.

More worrying was the slowdown in services activity, with the services PMI out today hitting a near 3-year low in February. The index fell to 52.7 from 55.6 in January and was sharply below forecasts of 55.1. The decline was mainly due to slower new business orders and this led to weaker jobs growth. However, there was some positive development in the Markit report, which showed the outlook for the year ahead improving to a 3-month high.

Sterling only saw a brief spike downwards from the services PMI as short covering appears to be driving up the British currency this week. The pound hit a 7-year low of 1.3835 dollars on Monday, as “Brexit” uncertainty intensified, before beginning a technical recovery and climbing back above 1.40 dollars yesterday. Against the yen, it hit the lowest since October 2013 on February 24, touching 154.70 yen. It managed to recover back above 160 yen today.

It’s been a different story against the euro though as the single currency is facing its own downside pressures. A British exit out of the EU would have a negative impact on the euro as well, but the prospect of more stimulus from the ECB as early as next week is also driving down the single currency. The euro has come off 2-year highs of 0.7928 pounds on February 25 to retreat to around 0.77 pounds today.

Despite this week’s disappointing PMI readings, the fundamentals for the UK economy remain largely unchanged. Strong consumer spending should support the economy during this soft patch and unemployment should continue to decline. However, uncertainty of the EU membership referendum in June could hurt growth if businesses put on hold spending plans until after the vote. Sterling is likely to continue facing downwards pressure in the run-up to the referendum.

Many analysts don’t expect the Bank of England to raise rates before polling day on June 23. Any signs of weakness in the economy in the meantime is likely to push back the timing of a rate hike even further and increase the downside pressure on the pound.

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