UK services sector figures were released this morning, showing a level of expansion not seen for thirteen months. In combination with strong construction data yesterday, this paints a much improved picture of the UK economy. It’s certainly a more positive picture than has been seen over the past few weeks following disappointing consumer confidence and retail sales data. Sterling has enjoyed a real boost on the back of the figures, climbing by 0.8% against the dollar, and over a 1% against the euro.
So how will this affect sentiment towards the UK economic recovery going forward? Well, it’s no secret that our economy is heavily geared towards the services sector (something the Conservative government are trying to amend but for the time being holds true). So the solid growth levels we have seen over the past three months in the services sector are broadly indicative of a decent GDP figure for the first quarter.
Current estimates for the April 27th first quarter GDP announcement are back up around 0.8% in light of today’s data. This matches the quarterly growth figure that we saw last summer, which was then followed by a 0.5% contraction in the final quarter of last year. It would perhaps therefore be premature to assume the UK’s recovery is guaranteed. However, the signs are certainly improving and, predictably, the debate surrounding when the BoE will raise interest rates has recommenced.
Over recent weeks, an August rate rise has been the dominant expectation. However, the brighter outlook for the economy indicated by data in the past couple of session has strengthened our case for a June rate rise. We still believe, along with 66 out of a survey of 67 economists, that a rate rise in Thursday’s BoE announcement is highly unlikely. We also believe that May will come too soon even if first quarter GDP comes in above forecast as the MPC will want evidence that the recovery can be sustained.
So what has today’s data done to our longer-term sterling outlook?
Major gains against the US dollar are still set to be limited by what we expect to be a slightly weaker euro over the coming weeks (the strength of sterling/US dollar has a close correlation with that of the euro/US dollar pairing). Nonetheless, we can see the pound hitting $1.6350 by the end of April, and climbing to €1.1650 against the euro.
These forecasts may be a little too sterling-positive for some. Sceptics towards the UK economy will require evidence of a more consumer-led recovery before investing in the pound, which in light of ongoing public spending cuts may be some time away. However, we believe specualtion of a second quarter BoE rate rise will provide enough fuel for some decent sterling gains.
Richard Driver
Analyst – Caxton FX
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