UK Market Confidence Grows

Discussion and Analysis by Charles Porter:

 

This morning, at 09:30 BST, IHS Markit released its Manufacturing Purchasing Managers’ Index. The data approximates managerial sentiment within the manufacturing industry and is thereby used as a proxy to understand the domestic macroeconomy. The latest release of this fast-moving index demonstrated a tick up in economic sentiment and confidence. Ahead of the Bank of England monetary policy decision, due tomorrow, the data led to an appreciation of the Pound Sterling of approximately 0.2%.

 

The purchasing managers’ index (PMI) is known as ‘soft’ data. This means that the underlying data, based upon survey responses, does not represent a tangible, value based, indicator of the economy. Instead, soft data measures sentiment and confidence. Concerning the manufacturing sector, this morning’s release shows the flash estimate of purchasing managers in October.

 

Positively, this makes soft data indices, such as the PMI, far more reactive to short term trends, allowing them to pick up on economic trends in a far more timely manner than traditional hard data. Negatively, the volatility of these indices and the normative, judgement, basis upon which they are formed means that their reliability should occasionally be questioned. Therefore, when the monthly change is negligible, the absolute value of the index publication should be qualified. The negative aspects of the soft PMI data are partially qualified by the extensive base of purchasing managers.

 

Today’s release was not magnificent when considered in terms of a month-on-month change. The revised data only moved up to 56.3, up 0.3 points from a previous 56.0. What is more important, and what moved currency markets, is the reversal of incumbent market expectations. The consensus forecast was for a moderate turn down of the managers’ index, with many market participants foreseeing a considerable decline in market sentiment.

 

An appreciation of the Pound Sterling following the release of IHS Markit’s index was therefore built upon the reversal of market expectation. Being an indicator of market sentiment, PMI expectations are likely to be a reflection of investors’ perception of market conditions. Therefore, it is likely that over the month of October, investors had internalised the more pessimistic market sentiment within the Pound Sterling transactions.

 

The release of PMI data that falsifies investors’ preconceptions about the UK manufacturing market creates the opportunity to price in UK manufacturing market sentiment. From the release, UK sterling markets gained just short of 0.2%, visible within the graph below.

 

 

The movement within Sterling-Dollar and Sterling-Euro currency crosses was diminished by the size of the manufacturing sector within the UK. With manufacturing accounting for less than 20% of the UK economy, according to calculations based upon Office of National Statistics data, the services sector dominates both trade and the domestic economy.

 

For an economy with low dependency upon the manufacturing industry, it is unsurprising that the currency market movements following the statistics release were not more magnificent. However, ahead of the Bank of England monetary policy decision due tomorrow at midday, confidence within the manufacturing sector will lend support to the initiative of a rate hike.

 

With a higher rate almost completely priced into UK Sterling markets and the Bank under increasing pressure not to disappoint market expectations, the PMI data may instead, in practice, facilitate a more hawkish monetary policy announcement. The role of interest rate expectations is a secondary factor influencing the currency market appreciation following the publication. For now, all eyes turn to the Bank of England tomorrow afternoon.