Sterling recovers as GDP data raises interest rate hike chances

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25 October 2017

Matthew Ryan

Senior Market Analyst at Ebury. Providing expert currency analysis so small and mid-sized businesses can effectively navigate international markets.

The Pound clawed back ground against its major peers this morning after the latest GDP data beat expectations, raising hopes that the Bank of England will hike interest rates next week.

T
he UK economy grew by a better-than-expected 0.4% in the third quarter of the year, its fastest pace of growth since the final three months of 2016. Unsurprisingly, the UK’s dominant services sector was behind much of the acceleration, more than offsetting a decline in construction output.

We were among the very small minority of analysts earlier in the year that had predicted the Bank of England would raise rates in 2017. Now, following recent hawkish rhetoric, high inflation and improving growth, markets are placing well over an 80% probability that policymakers in the UK will raise rates for the first time in a decade when they meet next month.

On Tuesday, renewed concerns over the state of the ongoing Brexit negotiations and doubts over whether the BoE would hike rates next month had sent Sterling crashing back below the 1.32 level against the US Dollar. European Council President Donald Tusk claimed that it was ‘up to London’ on how Brexit talks will end, stressing that Britain could still choose to remain within the European Union.

US services sector grows by most in eight months

The US Dollar ended trading modestly lower against the Euro yesterday, with investors overlooking an impressive services PMI in favour of expectations for a major policy announcement from the ECB on Thursday.

Yesterday’s US business activity services PMI came in better than expected, further raising expectations that the Federal Reserve will hike interest rates again before the year is out. The index increased to 55.9 versus a 55.6 consensus, its highest level in eight months. October’s manufacturing PMI was equally encouraging, rising to a nine month high 54.5. The US economy appears to have emerged unscathed from the recent extreme weather in the country and looks on course to expand at a sufficiently fast enough pace to warrant multiple interest rate hikes by the Federal Reserve in 2018.

Durable goods orders data this afternoon could shift the US Dollar if we see a material departure from consensus when released at 13:30 UK time.

Euro edges higher ahead of Thursday’s ECB meeting

Investors mostly brushed aside Tuesday’s disappointing set of PMIs and instead focused on the likelihood that President of the European Central Bank Mario Draghi will announce on Thursday that the ECB is ready to begin tapering its quantitative easing programme. Output in the services industry was especially disappointing, dragging the all-important composite index back from September’s four month high. The composite PMI, which represents a weighted average of both the manufacturing and services sectors, slowed to 54.9 from 56.7

With no major economic releases in the Eurozone today, currency markets will firmly shift their attention to Thursday’s ECB meeting. Policymakers in the Eurozone are expected to announce both an extension and a reduction in monthly asset purchases. As we have mentioned in our ECB preview report, recent communications out of the ECB lead us to believe that Mario Draghi will disappoint the market by maintaining his cautious stance. We expect a more modest reduction in monthly purchases of €20 billion or less and an extension of at least nine months, both of which we think would send the Euro lower against most major currencies.