Pound and euro slump to multi month lows after dismal PMIs
It’s been a bad day for economic data this side of the Atlantic. European and UK PMIs fell into contraction territory for November, and UK retail sales for October were much weaker than expected. This does not paint a pretty picture for the European and UK economies in Q4, and contrasts sharply with the outlook for the US, the Atlanta Fed’s GDPNow estimate of Q4 YoY GDP is 2.6%.
The UK PMI reports saw declines in both the manufacturing and service indices, which brought to an end a 12-month period of expansion. The manufacturing sector index fell further into contraction territory this month and is at its lowest level since February. The service index managed to stay at 50, which indicates expansion, however it was the weakest reading since October 2023. This suggests that the all-important service sector is losing steam as we move through Q4. The weaker than expected service sector reading helped to push the composite index into contraction territory at 49.9. Today’s data increases the chance of a recession in the UK in Q4, to avoid this scenario, December will have to be a bumper month.
Budget to blame for weak PMIs
These PMI surveys suggest that economic confidence has not picked up after the Budget. There has been a wave of criticism of some of the measures announced in the Budget, which is weighing on the private sector. Although PMIs do not measure actual activity, sentiment matters. While PMIs underestimated actual economic growth in the UK in the first half of the year, it appears that sentiment and actual growth are converging. Sentiment indices are the lead indicator, and this does not bode well for the UK economy.
S&P Global, who put together the PMI reports, said that November data suggests that total new business across the private sector was the weakest in a year. The respondents cited multiple headwinds including subdued business confidence and caution among clients in the wake of the October Budget. However, there could be brighter skies ahead, as some respondents noted that clarity after the US election could have a positive impact on demand. Cost pressures accelerated and the employment index fell, suggesting that job losses are coming. This week multiple large retailers in the UK along with the Post Office, have all reported that they are going to cut jobs to adjust for higher costs and tax rises included in the Budget. Business optimism has slumped sharply in the aftermath of the UK election, and companies are clearly unimpressed with the Labour government’s economic agenda. After Thursday’s public sector finance data, this has been a bad week for the UK Chancellor, who is professing to be pro-business. This data suggests that what she wants to be and what she is, are two different things.
Rising energy costs could weigh on UK growth this winter
Rising energy prices are hitting sentiment, and input costs rose at their fastest pace since July. For now, this is not being passed on to the consumer. Prices charged inflation continued their downward trajectory in November, which is a sign that UK companies have lost their pricing power, which could jeopardize economic growth and corporate earnings in the coming months.
The market reaction
In the aftermath of the PMI survey, expectations for a UK rate cut in December have risen to 14% from 9%, and rate cut expectations have increased for 2025. The market now expects rates to be 4.15% in June next year, down from 4.19% on Thursday. UK bond yields are lower across the curve, although European bond yields are leading the charge. The pound has tanked to its lowest level since May and is now approaching $1.25 as we move to the end of the week. Currently GBP is lower by 1.25% vs. the USD this week, and it has been another bruising week for the pound. There is no reason to buy the pound now, as the UK economic outlook continues to disappoint, and the economic surprise index for the UK remains close to its lowest level since March.
Europe: Super-sized ECB rate cuts expected
European PMIs were all weaker than expected for November. The manufacturing PMI fell further and is back at 45.2, the service sector index fell sharply, dropping to 49.2 from 51.6. This dragged the composite index into contraction territory for only the fourth time this year, and the composite survey fell to a 10-month low. This is a worrying development and suggests that the private sector will act as a drag on growth in the currency bloc in Q4.
EUR/USD also slumped in the aftermath of this report and is at a two-year low, after falling another 1.8% so far this week. The outlook for the pound and the euro are both bleak, which only increases the USD’s attractiveness. The Eurozone data has increased the chance of more rate cuts from the ECB next year. The market is certain that the ECB will cut rates next month, however there is now a decent chance of a 50bp rate cut. Eurozone interest rates are now expected to be 1.67% by October next year, this is down 1.8% on Thursday. Thus, investors have been jolted into recalibrating interest rate expectations on the back of this bleak economic news.
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