Sterling Looks for Positive PMI Surprise

As UK markets open for their first trading session of 2012 and funds return from the break to make their first plays of the year, the PMI manufacturing data will be watched closely. It will have an important impact on market sentiment, especially given the debate over UK recession risks. There is the potential for an upside PMI surprise on technical factors which would also trigger an immediate Sterling spike higher as short positions are scaled back.

The PMI data will certainly be important for underlying sentiment, especially as it is one of the earliest pieces of real data available with the manufacturing data on Tuesday followed by the construction and services-sector data over the next two days. There has been a general tone of UK pessimism over the past few weeks as the Euro-zone crisis has hit home, but it remains extremely difficult to quantify the scale of the damage. There is evidence that retail spending levels held relatively firm, but several prominent retailers are rumoured to be in trouble as profit margins come under further pressure and overall survey evidence has been mixed.

The manufacturing series weakened very sharply from the first quarter of 2011, declining from a peak of 62 to below the 50 level in just 6 months. Four of the last five releases have been below the 50 level, but there has been some evidence of stabilisation at 47.6 for December. Any figure below the 46.5 level would signal increased alarm and any outcome below 45 would result in heavy Sterling selling. In contrast, there will relief if there is a figure above 48.5 and Sterling’s safe-haven status would receive an important boost if there is a return to above 50. There will also be safe-haven Sterling support if all three UK surveys show a recovery this week.

The Bank of England is always extremely wary of making policy changes around year-end, especially as data releases can be prone to large distortions given the difficulties in accounting for a surge in spending surrounding the Christmas period. It is, therefore, unlikely that the PMI surveys will trigger any immediate central bank response unless there is an extremely weak figure. The data will be important in setting the underlying market tone, especially as the Bank of England will certainly consider further quantitative easing in February.

Although the data is seasonally adjusted, there can be big monthly distortions caused by weather-related conditions or holidays and there could be a crucial impact this year. December 2010 was extremely cold in the UK with record-low temperatures which disrupted activity in all sectors of the economy and there was a notable impact on the construction sector. The conditions in 2011 could hardly have been different with temperatures close to record highs. This will inevitably have had a positive impact on the economy as climate-sensitive areas such as construction and transport will have been able to work longer which will have had a knock-on positive impact in other areas of the economy and should have a significant impact in boosting the index.