by Adam Solomon
Sterling / Euro and US Dollar exchange rates
Following on from last week, the Pound declined to 1.6113 against the US Dollar exchange rate on Friday, but the UK currency found support versus the Euro for a second day and made unlikely gains versus a basket of currencies, as the latest manufacturing figures were slightly better-than-expected. Manufacturing contracted for a second month and by the most in over two years in August, led by weakening domestic and overseas demand, as the global economy slows.
The PMI index fell to a reading of 49 last month, the lowest level in 26 months, but the pace of the decline wasn’t as bad as initially feared, which helped curb Sterling selling. Support for the Pound is unlikely to last because the data still shows underlying concerns about the pace of the UK economy in the third quarter. The Nationwide Building Society reported that UK house prices fell by the most in almost a year last month, citing a weakening economy, which has undermined demand.
A level below 50 on the PMI manufacturing index indicates contraction in the sector, while the new orders component fell by the most in almost 2 ½ years and employment declined for the first time in 17-months. Although data in the U.S showed that manufacturing unexpectedly improved in August, figures from Europe showed a broader decline in factory production, which helped the Pound rise significantly through 1.13 and peak above 1.14 over the weekend.
Consumer and business confidence alike are slumping in the UK and overseas and the recent drop in new export orders will be particularly concerning because of a lack of demand. The pace of increases in input and output prices also eased in August with the former rising at the slowest pace in 20-months, which indicates that the pace of inflation may also be receding, reducing the need for an interest rate increase.
The British Chambers of Commerce last week lowered its UK economic growth forecasts for the year, while separate reports indicate that consumer sentiment declined for a third straight month and house prices dropped by the most since October. The UK economy barely grew in the second quarter and it is becoming increasingly likely that GDP will drop into negative growth during the three months to September.
The BCC also expect the Bank of England to keep interest rates unchanged at a record low of 0.5% until August 2012. As recently as March, futures markets were anticipating an increase in the benchmark rate by May this year. Policy makers have had little choice but to allow inflation to accelerate at the fastest pace in over 20-years, amid concerns about the sustainability of the economic recovery.
There will be continuing expectations that the economy is weakening, especially if there is any deterioration in the services-sector data due early this week. The Bank of England will keep interest rates unchanged on Thursday and markets will be watching for any hints that the MPC are preparing to renew the quantitative easing plan in the near-term.
The Pound briefly traded higher against the U.S Dollar ahead of Friday’s non-farm payrolls, but a disappointing figure encouraged demand for the safest assets. The UK construction PMI index fell to a reading of 52.6 for August, from 53.5 previously, which represents the lowest output since December. The EEF was broadly optimistic surrounding the manufacturing sector in its latest report, but underlying confidence will remain weak.
Euro / US Dollar exchange rates
The Euro exchange rate was unable to sustain an advance through the 1.44 level against the U.S Dollar last week and sold off aggressively by Friday, as the single currency broadly weakened against a number of currencies, trading at the lowest level since mid-August. The latest PMI data in the Euro-zone was weaker-than-expected with the revised manufacturing index slumping to the lowest level since June 2009.
There were also further concerns surrounding the European banking sector, amid reports that many banks were effectively shut out of international markets or holding too much bad debt. The ECB stepped up buying of peripheral bonds, but the impact was less than seen in previous days and the Euro struggled to bounce back from the negative result of the latest Spanish auction.
The Euro exchange rate is also under pressure amid speculation over a more dovish stance from the ECB governing council this week and there is a chance of a cut in interest rates to support the economy. In the U.S, the latest manufacturing PMI provided some relief for the Dollar, as the survey only fell to 50.6 for August, from 50.9 previously.
U.S unemployment held steady at 9.1% while payrolls were revised up by 85,000 for the previous month. There will be additional pressure on the Federal Reserve and the government to provide support to the labour market and boost consumer spending. There has been further Euro weakness this morning following defeat for the German Chancellor Angela Merkel in state election, which also increased political tensions in Berlin.
Today’s Exchange Rate Data
U.S – Labour Day Market Holiday
EU 08:58 – Markit Services PMI (August) – Composite
U.K 09:30 – CIPS Services PMI (August)
EU 09:30 – Sentix Investor Sentiment (September)
EU 10:00 – Retail Sales (July)