UK: the good times are here again?

Today’s manufacturing PMI data from the UK was yet another sign that the UK’s economic recovery is continuing into the third quarter. This survey was important not just because it picked up to 54.6, its highest level since March 2011 and the fourth consecutive monthly rise, but also because it suggests that the manufacturing sector in the UK, about 10% of GDP, continues to gather pace.

Manufacturing: have we found the missing piece of economic recovery?

The statement released at last month’s BOE meeting sounded unimpressed with the UK’s economic recovery, and the Bank was still concerned that the economy is 3% below its pre-recession peak. However, the reason for the UK’s weak recovery and the fact that the economy is still smaller than it was 5 years ago has been mostly due to hefty contraction in manufacturing and construction sectors. Hence, for the economy to return to its pre-recession size then an improvement in the manufacturing sector is crucial.

The details within the manufacturing report were also strong: new orders and output rose at their fastest pace since February 2011. Strong new orders are particularly important, as it suggests activity in the manufacturing sector could be maintained in the coming months. There was good news on the employment front also – factories are showing more appetite to hire new workers compared with subdued employment growth over the last 2 years.

Carney and the economic upturn in the UK

Hence, the BOE may reference the continued recovery in slightly more upbeat tones, if (and it’s a big if) it releases a statement at the conclusion of its meeting later today. As most talking heads have already pointed out, today’s BOE meeting is unlikely to be the main highlight, with Carney delivering his first Inflation Report next week. We expect forward guidance to be announced then and we also look for an upgrade to UK growth forecasts.

So what does this all mean for UK assets? There is a lot of uncertainty surrounding today’s meeting and we would expect the pound to be extremely sensitive around midday BST/ 0700 ET when the BOE decision is announced. If the BOE does release a statement and does not mention forward guidance (instead leaving us waiting for the Inflation Report) then, combined with the upbeat PMI report, we could see a mildly bullish tone in GBPUSD and some further weakness in EURGBP.

GBP: investors wary to be too upbeat ahead of Inflation Report

The pound surged on the back of the PMI report, rising above 1.5200 and eradicating earlier weakness. However, while there could be some upward pressure on GBP if the BOE does not mention forward guidance today, we think gains will be capped at 1.5295 – the 100-day moving average as investors are reluctant to put on long GBP positions ahead of the BOE meeting. Overall, an environment of low rates and better than expected growth is good news for UK stock markets.

Greece: a light at the end of a long, long tunnel

The UK wasn’t the only place where there was good news on the economic front. Greece’s manufacturing PMI also rose to a 3 year high, rising to 47.0 from 45.4. This remains some way from the crucial 50.0 level, but at least there is a light at the end of the tunnel. However, there is still some way to go. Employment growth is non-existent and new orders shrank further in July. So we shall have to wait and see if this truly is the start of a more positive tone to Greek data or another false economic dawn.

Greece is the periphery of the periphery in Europe right now, especially after the IMF identified another EUR 11 billion short fall in its finances for 2014/ 15. However, that is ok, as its cash crunch comes after the German elections next month, so we doubt there will be a spike in sovereign concerns in the near term. Returning to the periphery – Italy and Spain both saw their manufacturing sectors rise into expansion territory in July, recording their strongest reading in the last 2 years. Germany’s manufacturing PMI for last month was also revised higher, which is a double whammy of good news as the best scenario for the Eurozone is a strong German core and a recovery in southern Europe.

Could the ECB be the star attraction today?

The ECB could be the star of the show today with the BOE waiting for next week’s Inflation Report to deliver any juicy policy nuggets for the markets to devour. But Draghi has to walk a tight rope today: how does he acknowledge the pick-up in growth while trying to keep short term yields low and limiting EUR strength? He is a master of the art of oratory, so we shall have to see what he pulls out of the hat at 1330 BST/ 0830 ET.

Elsewhere, the Fed statement last night didn’t confirm or deny tapering would take place this year. Instead it is merely confirmed that rates will remain low even when the Bank ditches QE3. This could cause some steepening of the US yield curve, which could be mildly dollar bullish in the near term. USDJPY reflected the similar stance in the Fed statement from its June meeting and its movement has been fairly limited. It is still below the 99.00 level, and may trade in a 97.50 99.10 range as we lead up to NFP tomorrow. We also expect 10-year Treasury yields to hover around the 2.6% level after recovering from the dip to 2.58% after Thursday’s Fed meeting.

Source: Forex.com

01.08.2013