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August 1st 2011: Preview - PMI data to test Sterling’s defensive credentials

 

The UK PMI manufacturing index on Monday is the first of three key indices to be released ahead of Thursday’s Bank of England interest rate decision and this run of data will be vital for the future of Sterling’s new-found defensive role.  If the PMI index signals industrial contraction with a move to below 50 for the first time since October 2009, then confidence in the economy will certainly deteriorate further and Sterling is likely to fall back towards a 1.6100 - 1.6330 trading range against the dollar. Any figure above 52.0 would provide initial relief and give a medium-term Sterling sell opportunity in the 1.6520 area.

The US debt fiasco and on-going Euro-zone crisis have combined to give Sterling an easy rise over the past few weeks. Indeed, remarkably,  the currency has been seen a fledging safe-haven which tells you all you need to know about the US and Euro-zone fundamentals.  Immediate defensive demand for Sterling is likely to decline with a US debt deal within reach and the PMI data will be crucial in determining whether there is a more serious deterioration in UK sentiment. The last four manufacturing PMI releases have been much weaker than expected with a decline to a 21-month low of 51.3 in the July survey and the consensus is for the index to be little changed this month.

The immediate impact of the manufacturing releases on monetary policy may actually be rather limited with the Bank of England looking to hold interest rates steady in the short term. There will, however, be a very important impact on sentiment.  This is a pivotal period for the economy and government, especially with weaker than expected growth and increased political stresses. If the economy is unable to make headway then confidence in the economic strategy will also continue to deteriorate and confidence in Sterling would also erode rapidly with the UK Chancellor under very heavy political pressure.

Rising exports will be critical for the UK if there is to be a sustainable recovery, especially as the consumer will remain under heavy pressure over the next few months.  If there is further evidence of the manufacturing sector deteriorating, then one of the key props required for a faster rate of recovery will be removed.

The industrial CBI industrial survey released last week, recorded a reading of -10 from +1 previously and there has been evidence that export growth has faltered in the face of weaker demand from within Europe. There will be some hope for signs of a recovery after the Japanese earthquake undermined output, but this may not materialise until after the Summer period.

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