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May 5th 2011: Market Preview -  UK PMI data to trigger another Sterling sell-off?

The UK PMI services data due on Thursday is the last piece of evidence before the Bank of England interest rate decision and will have a substantial impact both on the market and the MPC committee.  The PMI data this week has already shown its impact with the manufacturing and construction releases both triggering initial GBP/USD losses of over 50 pips.

The services data also has a very solid track record of producing big market impacts over the past two years, especially as the sector remains dominant in the UK and another big reaction can be expected this time.

Looking at the last 12 releases, 6 have been worse than expected and 4 have been better while 2 releases were neutral.  Last month’s data was much stronger than expected, but the evidence from the other sectors is that there will be a significant retreat this month.

The main argument of the MPC doves is that a weak economy with plenty of excess capacity will keep underlying inflation down, especially with consumer spending and real incomes under pressure.  The hawks meanwhile claim that rising inflation pressures much be tackled through higher borrowing costs.

If there is a significant deterioration in the services PMI index, the dovish argument will continue to be much stronger within the MPC meeting, especially with weakness in the other business surveys. If, instead, the index rises strongly, then pressure for an interest rate hike will return as it would suggests that the economy is stronger than expected.

The net risks suggest a weaker than expected figure is likely which would damage Sterling and any figure below 54.0 would trigger losses in the order of 100 pips while a figure above 57.0 would trigger initial gains of around 50 pips. Caution is certainly required given that Sterling will also be caught in the cross fire of Euro and commodity-price moves, but there is a solid case for selling GBP/USD on rallies to the 1.6550 area ahead of the data.

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