GBP/EUR: Manufacturing PMI Data Under The Spotlight After Gloomy Outlook for UK

The pound ended Monday’s session flat versus the US dollar at US$1.2290. The pound is recovering from early losses on Tuesday as it pushes back towards the US$1.23 mark.

Slightly better than forecast UK manufacturing data helped sterling recover from early losses against its peers on Tuesday. UK manufacturing activity rebounded in September from August’s seven year low.

The contraction in the UK manufacturing sector unexpectedly slowed, with the PMI jumping to a 4-month high of 48.3. This was above than the 47.1 that analysts had forecast. Whilst the data is an improvement, it still shows that the UK manufacturing sector remains in the doldrums. Of particular concern, new orders and employment levels declined pointing to a potential sector recession.

With Brexit just a month away manufacturers saw many customers shift their supply chain away from UK. European customers are making firm plans to eliminate their reliance on UK manufacturing suppliers. The outlook for the sector remains grim, which has kept a lid on sterling’s gains.

Investors will now turn their attention back to Brexit with Prime Minister Boris Johnson expected to submit formal proposals for an alternative to the Irish backstop on Wednesday. Investors will be waiting for the reaction from Brussels. Any sign that a new Brexit deal could be achieved, could send the pound higher.


Why is a “soft” Brexit better for sterling than a “hard” Brexit?
A soft Brexit implies anything less than UK’s complete withdrawal from the EU. For example, it could mean the UK retains some form of membership to the European Union single market in exchange for some free movement of people, i.e. immigration. This is considered more positive than a “hard” Brexit, which is a full severance from the EU. The reason “soft” is considered more pound-friendly is because the economic impact would be lower. If there is less negative impact on the economy, foreign investors will continue to invest in the UK. As investment requires local currency, this increased demand for the pound then boosts its value.


US Manufacturing Data In Focus

The dollar was in favour in the previous session and continues to drive higher in early trade on Tuesday. Recent data from the US hasn’t been outstanding but it hasn’t been bad either. The US economy has shown resilience despite the ongoing US — China trade dispute and as an economic slowdown engulfs the rest of the world.

The fact that the Federal Reserve are in no rush to cut interest rates further is also offering support to the US dollar, as central banks across the globe ease monetary policy.

Today the dollar could get a boost when US manufacturing activity data is released. The US manufacturing sector has been the weak link in the US economy. The sector contracted in August. However, analysts are predicting that US manufacturing activity picked up again in September, pushing back into expansionary territory. A strong reading could see investors push back further on the probability of another rate cut by the Fed this year.


Why do interest rate cuts drag on a currency’s value?
Interest rates are key to understanding exchange rate movements. Those who have large sums of money to invest want the highest return on their investments. Lower interest rate environments tend to offer lower yields. So, if the interest rate or at least the interest rate expectation of a country is relatively lower compared to another, then foreign investors look to pull their capital out and invest elsewhere. Large corporations and investors sell out of local currency to invest elsewhere. More local currency is available  as the demand of that currency declines, dragging the value lower.



What do these figures mean?
When measuring the value of a pair of currencies, one set equals 1 unit and the other shows the current equivalent. As the market moves, the amount will vary from minute to minute.

For example, it could be written:

1 GBP = 1.28934 USD

Here, £1 is equivalent to approximately $1.29. This specifically measures the pound’s worth against the dollar. If the US dollar amount increases in this pairing, it’s positive for the pound.

Or, if you were looking at it the other way around:

1 USD = 0.77786 GBP

In this example, $1 is equivalent to approximately £0.78. This measures the US dollar’s worth versus the British pound. If the sterling number gets larger, it’s good news for the dollar.


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