Stronger than expected economic output – Sterling Update

GBP

The recent trend of gradually improving UK sentiment, aided by stronger than expected economic output continued through this week. The latest PMI report saw both the Composite and Services components move strongly back over the key 50* threshold, with the former surging from 48.5 to 53 and the latter rising from 48.7 to 53.3. Manufacturing also improved, jumping from 47 to 49.2, and falling just short of the magical 50 level*.

On the same day, the latest UK public sector finances were released. During January, there was a surprising £5.4bn surplus against an expected deficit of around £7.8bn, with the increase boosted by a big surge in tax receipts. The yearly figures also highlighted a strong beat, with the public sector borrowing around £111.9bn, which was roughly £30.6bn less than had been forecast by the OBR, just a couple of month’s back in November. That is a big beat.

The improvement in public sector finances could see the government use the extra cash to give muted 5% pay rises across the board to public-sector workers, who have been striking relentlessly throughout the winter in a bid to improve their pay and conditions. The government might alternatively use the extra cash to help fund extra spending plans. With the March budget just around the corner, the timing really could not have been any better for the government.

The broad pound has responded well to the news, with the likes of GBP/EUR moving up strongly over the past week from around 1.1200 to just under 1.1400. GBP/CAD rallied from 1.6100 to 1.6400 at one point. GBP/USD is an altogether different animal, and having initially rallied as high as 1.2150, suffered losses alongside most of the other major currencies against the dollar, slipping back towards 1.2000 by the end of the week. Next week will be dominated by the latest speech from BoE governor Andrew Bailey, to see whether there has been any material change on the BoE’s rate outlook, given that improving backdrop. Indeed, the BoE’s Catherine Mann was on the wires earlier in the week, suggesting that further rate rises will be needed to arrest sticky inflation.

*Above 50 is considered expanding, below 50 is considered contracting for an economy

EUR

With Core regional Harmonized inflation surprisingly rising to 5.3% (YoY/Jan) from 5.2%, it is perhaps no surprise that the ECB continue to imply that they will definitely be hiking euro area rates by another 50bps at their next meeting. Whilst not rising, the stickiness of German inflation will also be a key factor impacting the ECB’s thinking. However, the majority of the other key data releases have shown upside surprises, which should give the ECB much more confidence to maintain the current rate trajectory.

Amongst that other data, there was a bit of a mix bag amongst the latest German IFO survey. Whilst Business Climate and Current Assessment missed expectations, the Expectations component rose, which suggests that businesses expect better conditions looking forward, which is a fair assessment, given improving sentiment across the region.

Having been on a solid run from September until the end of January, the single currency has found the going much tougher this month, with EUR/USD slipping from a high of over 1.1000, to under 1.0600 by yesterday, primarily driven by the surging greenback. That dynamic is likely to persist for the time being, unless the ECB move to an even more hawkish outlook on rates, or the Fed start to get all dovish on us. Looking ahead, key unemployment and more inflation data are both set for release across the region next week.