UK 8217 s Latest Data Boost to GBP

UK August manufacturing PMI hit a 30-month high at 57.2, marking the 5^th monthly rise, an improving streak not seen since 1994. The 57.2 figure exceeds all other major economies’ services PMIs, which currently stand at 55.4, 51.8, 51.4 and 51.0 for the US, Germany, Eurozone (composite) and China.  The same story applies for services PMI, where the UK figure stands at 60.2, well above the 56.0, 54.1, 52.4 and 51.0 for the US, China, Germany and Eurozone.

As the data continue to improve, the yields story shows no relenting.  The differential of UK 10-year yields over their US and Germany counterpart stands at its highest level in 7 months and 9 months respectively.  The chart below illustrates the decline in the German-UK yield spread to have nearly quadrupled since April, while EURGBP remained little moved from its 0.85 average. Medium term momentum signals indicate further deterioration in the German-UK yield spread, possibly reaching -0.85% to -0.90% in the medium term.

 Theoretically, this would suggest ongoing weakness in EURGBP. The fundamentals for such a decline would be feasible: increased dissent in the Bank of England from the hawkish camp; further yields back up by bond traders as a response to the BoE’s insistence to keep policy rates low and contain market rates; firm reiteration by the European Central Bank’s forward guidance to keep rates low; and renewed pressure on the Eurozone to offer a 3^rd bailout for Greece.

As sensible as the aforementioned dynamics appear, EURGBP continues to be supported atop the 14-month trendline support at 0.8430s. After breaking out of its 4 ½ year channel for five straight months, EURBP is now reverting lower.  But in order for EURGBP to break below 0.84, far-reaching policy changes must involve the two central banks. Even if the ECB gives up its hints at negative rates, it is unlikely to allow EURUSD to make another visit towards 1.37.  The situation with Greece’s access to capital markets in 2014 isn’t expected to resurface until later this year.

But developments on the GBP front are likely to be more fluid. A new BoE governor, 2 new members at the MPC and a “forward guidance”, with which the BoE has yet to familiarize itself. UK jobs figures, besides CPI, are growing in importance and volatility won’t diminish any time soon. There is also the topic of credit rating. The UK was stripped of its AAA rating by Moody’s and Fitch in February and April respectively, while S&P sticks to its AAA grade since 2011.  Any change as far as outlook or rating are concerned should impact the cross.  As it stands, the immediate path is likely to be in favour of GBP vs EUR in yields and currency. But it will take greater policy chance in order for 0.84 to be taken out.