The UK composite PMI experienced a drop to a 2-month low, reaching 51.0, compared to the June figure of 52.0. This decline was mainly due to a slowdown in the services sector, where the PMI fell to 51.2 from June’s 52.8, although the manufacturing PMI saw improvement, increasing to a 6-month high of 48.2 from the previous 47.7.
In July, private sector businesses charged higher prices, leading to a resurgence in the rate of inflation for the first time since April. The consistent underlying inflation restricts the Bank of England’s ability to increase easing measures aimed at supporting economic growth. The swaps market predicts a 95% chance of a 25bps rate cut to 4.00% at the upcoming August 7 meeting, with a cumulative 75bps easing expected over the next year.
Challenges For The Pound Sterling
The challenging UK economic environment, characterised by slow growth and high price pressure, presents difficulties for the Pound Sterling, especially against the Euro.
We believe derivative traders should anticipate increased weakness in the Pound Sterling. The decline in the services PMI, the UK’s dominant economic engine, points to a slowdown that will likely force the Bank of England’s hand. This view is supported by the latest S&P Global survey which highlighted weakened domestic demand as a key factor behind the slowdown.
The resurgence in price pressures, despite slowing growth, creates a difficult environment. While the latest official CPI inflation reading for June was 2.0%, the forward-looking PMI data indicates businesses are already raising prices again, a sign that underlying inflation remains sticky. This conflict between slowing activity and stubborn prices puts the central bank in a bind, but the need to support growth will likely take precedence.
Strategies For Traders
Traders should position for the high probability of a rate cut in August, as currently priced by the swaps market. Historically, the start of an easing cycle tends to weaken a currency, especially if other central banks are not moving as quickly. We see value in strategies that profit from falling UK interest rates and rising bond prices over the next several months.
The most direct trade appears to be shorting the Pound against the Euro. The UK’s stagflationary environment contrasts with the Eurozone, where recent data, though soft, does not show the same level of acute price pressure combined with slowing growth. This policy divergence should favour the Euro, making derivatives like EUR/GBP call options an attractive way to express this view.
