In the UK, the preliminary PMIs for May hit the markets at. 08:30 GMT Thursday, ahead of retail sales in April at. 06:00 GMT on Friday. PMIs are expected to rise but remain deep within contracting waters while retail sales are grounded to a record decline. As far as the pound is concerned, it gets knocked out on all sides. The UK economy is opening up very slowly, investors are worried that today’s exploding deficit will result in savings policies tomorrow, BoE is considering negative rates, and to top it all, the risk of Brexit not trading is back on the radar.
PMIs to improve from depressed levels
The UK economy was among the last to go into lockdown at the end of March, and with the health crisis still raging, it is only natural that it would be among the last to reopen. Economic growth in March – which only caught a few days after the shutdown – was a disastrous -5.8% and April data may be even worse. In fact, retail sales for April are expected to show a -16% drop from the previous month.
But the PMIs for May are set to provide a glimmer of hope. The manufacturing index is expected to mark up to 36.0 from 32.6 in April, while the important services print is seen at 25.0, a notable improvement from the lowest time of 13.4. Unfortunately, while these increases would be encouraging, both numbers would still be far from the 50-level separating expansion from contraction, signaling that the economy remains in a deep recession.
Sterling besieged from all sides
When it comes to the pound, it’s been pain lately in the middle of a toxic cocktail of development. First, markets were not impressed by the government’s handling of the health crisis, as the early hesitation to close the economy now means a longer period of things that remain closed. Secondly, there is growing fears that the burgeoning government deficit will result in “austerity tightening” austerity when the crisis ends, either through tax increases or through spending cuts or both, demand destroys as the recovery begins.
Third, Brexit negotiations have resumed, but they have been fruitless and we may be heading for more drama soon. The UK has until the end of June to decide whether it will extend the current transitional period beyond December, and Prime Minister Johnson has been most adamant that he will not. If not, it would make a no-deal Brexit by the end of the year the default setting, and while this may ultimately be a bargaining tactic by Johnson on expressing concessions, the threat of an exit trade is certainly not will haunt sterling over the summer.
The last nail on the coffin is that the Bank of England is considering negative interest rates. Some politicians – including chief economist Haldane – recently pointed out that they would be open to it. It is a controversial option because, based on the European experience, it is estimated that negative interest rates could weaken the financial sector on which Britain’s desperately depends.
However, note that this can also be a “trick”. By not excluding anything, the bank can cause markets to invest in negative interest rates, which loosens economic conditions and has similar effects as an interest rate cut – but without actually reducing interest rates. Either way, however long as this option is on the table, it is just another factor that will limit any sterling upside.
Looking at sterling / dollar technically, it has been trading down a downward line since early May, and if the Bears remain accountable, their next target could possibly be the 1.2165 zone.
If the bulls penetrate above 1.2265 and the downward line, the next area offering resistance may be close to 1.2305.