Brexit Bites – UK PMIs at 41 Month Lows

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Market Drivers July 22, 2016

UK PMI hit 41 month lows
EZ PMI mostly in line
Nikkei -0.89% Dax -0.03%
Oil $44/bbl
Gold $1324/oz.

Europe and Asia:
EUR EZ Flash PMI 52.9 vs. 52.5
GBP UK PMI Manufacturing 47.4 vs. 48.7
GBP UK PMI Services 49.1 vs. 48.7

North America:
CAD CPI 8:30
CAD Retail Sales 8:30
USD PMI Manufacturing 9:45

UK PMIs in July cratered falling to 41 month lows in the aftermath of the Brexit vote, sending GBP/USD tumbling more than 100 points lower in morning London trade.

Both UK Manufacturing and UK Services PMIs dropped sharply with Manufacturing printing at 47.4 from 52.1 the month prior while Services came in at 49.1 versus 52.3 the period past. On the services side the new orders component essentially cratered dropping to 45.5 from 52.3 prior suggesting that business pulled orders in the aftermath of Brexit. This is crucial to the health of the UK economy as services represent the vast bulk of UK economic activity.

With both PMI gauges now firmly below the 50 boom/bust line the prospect of further easing from the BoE in August appears assured. The only question is whether UK policy makers will cut rates by 25bp or drop them by fully 50bp to zero.

The sharp drop in PMIs also suggests that UK GDP in Q3 will likely contract for the first time since March of 2013 although it may be too early to tell whether the impact of Brexit will send UK into a full blown recession this year. The action in July was a clear reaction to the shock of Brexit vote, but with UK policy makers in no rush to invoke Article 50 and begin the process of separation, business confidence may revive next month which could ameliorate some of the impact of the sudden contraction in demand.

Ironically enough the more the UK economy deteriorates the less likely Brexit will become a reality as public opinion will turn sharply against it and the PM May, who had campaigned on the Remain side will likely try to work out some sort of compromise with EU. For now however, GBP/USD will become ever more sensitive to economic data as markets will want to see whether the impact of the Brexit vote is translating to a sustained contraction in demand. Cable tested the 1.3150 support in the aftermath of the report and may drift towards the 1.3100 level as the day proceeds.

Elsewhere, the PMI data from the EZ was essentially in line helping to support the euro above the 1.1000 level, but the pair is having a difficult time generating much of a rally. Yesterday’s somewhat dovish presser by ECB President Mario Draghi in which he reiterated that the balance of risk was still skewed to the downside and that the central bank stood ready to accommodate further is keeping a lid on the upside for now.

With US calendar only carrying the PMI Manufacturing release on the docket, the price action in the US session may be subdued, but any downward drift in equities could put fresh selling pressure on EUR/JPY and take EUR/USD below the 1.1000 mark once again.

Boris Schlossberg
Managing Director

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