UK Manufacturing Data Soft, Dollar and Sterling Weak

BBH CurrencyView

• US dollar continues to weaken ahead of tomorrow’s ECB and BoE meeting
• UK manufacturing much weaker than expected; Swiss CPI exceeds estimates
• Euro remains resilient ahead of ECB meeting; Portugal raises €1 bn in auction

The dollar continues to weaken, paring yesterday’s gains, ahead of tomorrow’s policy decision from the ECB and BoE, with the outlook for central banks remaining the key driver. The euro is making new cycle highs, now above 1.43, in line with the broad dollar weakening trend while March’s Swiss CPI underlined global inflation worries. USD/JPY lost steam ahead of ¥85.50, while UK production highlighted the uneven tone of the UK economic balance (although sterling found support ahead of $1.626).. Global Equities are mostly flat, with the MSCI Asian Pacific down 0.06% and European bourses up marginally, by 0.2%. US futures are pointing to a small positive open. Sovereign debt are little changed with the exception of 2-year Greece debt, which is up 22bps, though the country’s longer dated bonds are just a couple of basis points higher. Oil prices are about 0.4% lower after reaching a new cycle high in yesterday’s trading. Brent is just below 122$/oz following a mixed US inventory report yesterday which showed that crude stocks fell more than expected, though gasoline inventories were higher. Gold, meanwhile, reached a new high of 1457$/oz.

UK manufacturing production weakened considerably, below expectations, bringing the annual rate down 4.9%. Overall, the data was quite disappointing and indeed will cast doubt on the strength of the economy and therefore the trajectory for MPC policy. But keep in mind that manufacturing accounts for only a relatively small share of the economy and yesterday’s surprise rise in the service figures supports moderate expectations of a rebound in GDP next quarter after the contraction in Q4 of last year. In addition, the underlying growth momentum of the manufacturing remains strong, despite the recent volatility and this print running contrary to some other surveys such as PMI, and thus should lead the MPC to look past this weak print. Sterling, meanwhile, hit session lows after the weak manufacturing print with the 2-year gilts declining 4bps prompting the loss. Sterling found footing ahead of $1.626 and is near the upper-end of its recent range, suggesting that sterling is unlikely to break through the $1.64 without clear impetus from the MPC. Elsewhere, the Swiss franc is the strongest performer in the G10 versus the dollar as Swiss CPI unexpectedly jumped, reinforcing expectations that emergency monetary policy may be running its course. That said, today’s print may underpin expectations that the SNB will not be able to stay on the sidelines for much longer and could have its hand forced to tighten policy at its next meeting in June in order to maintain long-term price stability, in line with other central banks.

The euro broke out to a new 14 month high above 1.4300 this morning. Tomorrow’s ECB meeting and the expected 25 bp hike remains in focus. US-German 2 year bond spreads are up 6 bp over the past week and have underpinned the euro’s resilience. While technical resistance at 1.4380 remains a key level with a break suggesting a test of the January high near $1.44 yet ECB comments tomorrow clearly can overwhelm levels in either direction. We suspect that overall Trichet will try to remain neutral and in turn attempt to key the market’s expectations of another immediate rate hike at bay. Elsewhere, Portugal raised 1 billion euros this morning in 6 and 12 month bill auctions. The 6 month and 12 month rates were 5.11% and 5.90%, respectively, versus 2.99% and 4.3% in the March auction. Even these much higher rates may have been influenced by government related purchases, as a Portuguese newspaper reported that the national Social Security fund was selling foreign assets to purchase bills today. The high rates Portugal is forced to pay makes a bailout that more probable. The country’s main banks have reportedly urged the government to take a bridge loan or they would stop buying government debt given their balance sheet constraints. There was also discussion about setting up an Emergency Liquidity Assistance program, similar to the Irish facility, which would help tie Portuguese banks over the current emergency period ahead of the June 5 election.