This mornings’ substantially better than expected UK manufacturing PMI release – rising to an 10-month high of 53.3 in August, versus market expectations of a smaller bounce to 49.0 after July’s 48.3 – has generated substantial market commentary. The broad-based nature of the bounceback was notable, with rebounds in both the output and new orders balances. So high-profile Brexit advocates have quickly claimed it as further evidence of limited economic costs of the vote, with some indeed questioning MPC’s 4 August “sledgehammer” policy easing. Sterling has commensurately bounced: £/$ up to around 1.326 from 1.315; €/£ down to 0.840 from 0.848.
While obviously welcome big-picture (no-one wants to see a UK recession unfold post-Brexit!) there’s several reasons for not getting carried away with the optimism (I also outlined caveats around the recent better than expected retail sales and labour market data here):
- The Brexit risks for the UK economy were always less about an immediate collapse in output and more about slow-burn negative impacts, especially via weaker fixed investment (plus employment and and durables consumption) given the uncertainties about the UK’s future EU relationship. PM Theresa May’s statement yesterday that loss of single market access is a price worth paying for controlling free movement of labour (see here) should worry businesses longer-term and hence weigh on capex.
- The manufacturing PMI bounce could overstate the underlying improvement in conditions (as well as potentially overstating July’s fall). Recall that it’s based upon qualitative not quantitative responses. So the bounce could reflects a large number of firms experiencing small improvements from the immediate post-referendum uncertainty rather than it really being boom time. After all, the world hasn’t yet ended post the Brexit vote, given that the Government is taking it’s time triggering Article 50. Indeed, the bounce in the output balance to 57.0 implies 3%-plus growth: but that’s stronger than in the US, which is stretching credibility.
- Consistent with that suspicion, the overall PMI bounce wasn’t as dominated by better export orders as intuition suggests it should have been given £’s substantial fall. Sure export orders balance bounced relatively sharply (mirroring the improvement in the CBI industrial trends analogue I discussed here) but they actually continued to track the overall orders balance and lay below the output balance. So the qualitative versus quantitative issue could be active.
- There’s also negative elements in the PMI release. Specifically, the sharp rise in input/output price balances reported in the PMI survey (see Chart) – both at 5-year highs – will feed through into CPI inflation and hence erode consumers’ purchasing power (real incomes) and hence weaken consumption going forward (which could be amplified by recent reports of weaker recruitment, see here).
- The bigger picture is that Manufacturing only accounts for 10% of the UK economy. The prospects for the service sector, which accounts for 80% of the economy, will be far more important in shaping the UK’s post-Brexit future. So next week’s services PMI will be closely watched. But other surveys have thus far painted a negative picture for services: this week’s quarterly CBI survey reported sharp falls in optimism in both business/professional service and consumer services, even if consumer services output remained stable while business/professional services output was the weakest since 2012 (see here). Moreover, services will tend to be less supported by sterling’s depreciation. And the longer-term threat to financial services, and hence the positive UK services trade balance, should the UK lose it’s EU passporting rights can’t be ignored.
- MPC adopted a conservative assumption about the near-term Brexit impacts – partly because they anticipated that the bounceback in the Lloyds Bank Business Barmometer could be mirrored in the PMIs (see here). So the “news” to MPC will be commensurately smaller and hence MPC are highly likely to still regard their August easing as justified given the longer-burn issues which will play out over the coming months. But overall, at the margin, today’s data reduce the chances of further easing alongside the November Inflation Report. But the situation remains fluid: next week’s services PMI data will be carefully watched.
The above means that £’s knee-jerk bounce continues to look fragile over the coming months. Indeed, there’s an inherent circularity in £ appreciating after the PMI release which was itself supported by the £’s previous depreciation! I discussed here how a further 30bp fall in 2-year OIS rates could be required for £/$ to fall to around 1.20, absent any risk premia effects from the funding of the UK current account deficit. And it’s worthwhile recalling that in August a majority of MPC members expected to cut Bank Rate further (likely towards a lower bound of 0.1%) if the economy evolved in line with their expectations.
That said, record short GBP positioning (see here) also limits near-term £ weakness: further £ upside could be required to inspire fresh shorts to be initiated absent awful UK data. Indeed, the likely slow-burn nature of the issue and hence the release of relevant data (on capex etc) mean’s its increasingly possible that £ could remain relatively flat until Article 50 is actually triggered (early 2017) or until the UK negotiating position becomes clearer. The negotiating positions of EU member states will obviously also importantly impact the likely macroeconomic costs of Brexit. And all the signs from the big players (Germany, France, Italy) continue to be that constraining free movement of labour will mean that loss of single market access, including UK banks’ EU passporting rights (see here).