UK Manufacturing tanks... Vlieghe to vote for rate cut?

Week Commencing Monday 10th May 2016

Overriding Market Themes

UK manufacturing activity contracted in April for the first time in three years, adding to fears over the country’s economic strength. The Markits UK manufacturing purchasing managers' index slipped to 49.2 in April from a downwardly revised 50.7 in March, missing expectations for a reading of 51.2. Markit indicated the headline index was dragged lower by lacklustre trends in production, as well as new orders and declines in both employment and stocks of purchases, while the decline in the manufacturing sector was mainly felt in the consumer and investment goods industry. New export orders fell for the fourth straight month in April, although the decline was only marginal, as global economic growth continued to slow, Markit added. Meanwhile, investment goods producers recorded a sharp decline in new export business, compared with the steady improvements recorded in the consumer and intermediate goods sectors. These make for worrying figures for Chancellor George Osborne, whose recent positive budget predictions have come under close scrutiny. This coupled with a myriad of questions surrounding a “Brexit” scenario, have worried those at number 10 and the market in general. Interesting times ahead!

Over in Germany, industrial output fell more than expected in March, however exports posed a surprisingly strong increase, pointing to a mixed performance by Europe's largest economy at the end of an overall solid first quarter. Production fell 1.3 percent from the prior month, when it dropped a revised 0.7 percent. Slowing global growth has led the German economy to rely increasingly on domestic demand, bolstered by record low unemployment. Yet business confidence deteriorated last month and the Bundesbank said that it expected slowing momentum in the second quarter amid global headwinds such as a slowdown in China.

 

GBP This Week

Thursday’s Bank of England Inflation Report is important for GBP but may deliver mixed signals as the Bank will likely revise lower its domestic and international growth forecasts, largely reflecting recent weakness in the Manufacturing PMI. Our base case is for the vote to remain unanimous for no change in policy settings in line with analyst and market expectations. It is possible, however, that Gertjan Vlieghe, one of the most dovish members of the MPC, will vote for a rate cut after noting in February that he has “relatively little tolerance for further downside surprises”. Since then UK data have generally disappointed, partly reflecting EU referendum uncertainty, forcing our data surprise index to its lowest level since the global financial crisis.

Elsewhere, Wednesday is an important day with Chancellor Osborne set to testify to the Treasury Select Committee on the recent Treasury report on a UK exit from the EU. March industrial production is likely to come in at 0.5% and manufacturing data to come in at 0.3%.

USD This Week

We expect the USD to trade the range against most majors after last week’s disappointing Non-Farm Payrolls report took the June rate hike off the table. This coupled with re-emerging weak Emerging Markets fundamentals should support the dollar against higher risk and Emerging Markets currencies.

In terms of data, we forecast import prices on Thursday to have increased 0.8% month on month in April, with a 0.3% month on month rise in nonpetroleum import prices boosted by higher prices for import petroleum products. We look for a robust April retail sales report on Friday, with solid expected readings across core categories likely boosted by higher gasoline prices and the bounce back in motor vehicle sales. We expect the University of Michigan index of consumer sentiment to be broadly unchanged in the preliminary reading for May. Finally, we expect the core PPI to be up 0.1% on the month and 0.9% on the year.

EUR This Week

This week, European Central Bank Vice President Constancio will speak several times, however the highlight will likely be Monday’s International Financial Services Forum in London where he will be delivering the keynote speech. In terms of data, German activity data should mostly beat expectations and include March factory orders, March IP and Q1 preliminary GDP. Elsewhere, March euro area Industrial Production on Thursday should be flat on the month, while final first quarter GDP on Friday should be confirmed at 0.6%, both in line with the consensus.

Interestingly, the Eurogroup will hold an extraordinary meeting on Monday to discuss the state of play of the macroeconomic adjustment programme for Greece. The provision of further financial assistance to Greece is contingent on a comprehensive package of policy reforms, and it will be interesting to see how European powers view Greece’s progress.

 

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