The services PMI out of the UK will be in focus for pound traders on Wednesday at 0830 GMT. But if the manufacturing and construction PMIs are anything to go by, there’s unlikely to be much to cheer about from June’s services activity report. Growing risks of a disorderly Brexit and signs the UK economy may have contracted in the second quarter have kept the pound on the backfoot since May.

UK growth outlook deteriorating fast

Things are not looking good for the British economy at the moment. After getting a boost in the first quarter from Brexit stockpiling, industrial output slumped in April, dragging GDP lower by 0.4% over the month as businesses run down their high stock levels. Furthermore, inflation remains low and even the strong labour market is showing signs of cooling off.

The closely watched PMI indicators by IHS Markit/CIPS support the deteriorating picture. The latest readings for the manufacturing and construction sectors were dismal in June. Both PMI fell deeper below the 50 neutral levels, with activity declining for a second straight month. The manufacturing PMI fell to the lowest in six years, while the construction PMI plunged to the lowest in 10 years.

Services PMI not expected to impress

The services sector, which makes up almost 80% of the UK economy, managed to return to growth in April after shrinking in March and is expected to hold in expansion territory in June. Forecasts are for the services PMI to stay unchanged at 51.0 in June.

Whether this would be enough to keep overall economic output from contracting in the second quarter remains to be seen. Consumer spending – the main driver of domestic demand – has weakened sharply since April and unless there was a solid bounce back in June, growth in the services sector is unlikely to have been strong enough to offset the falling output in the other sectors.

Pound stuck in the doldrums

So where does all this leave the pound? GBP/USD is currently testing the 61.8% Fibonacci retracement (1.2611) of the June up-leg. A break below this support is likely if the services PMI disappoints, turning the focus to the 78.6% Fibonacci at 1.2564, followed by June’s 5½-month trough of 1.2504. If there’s a big miss in the data, GBP/USD could head towards the 123.6% Fibonacci extensions at 1.2438, especially if the dollar rebounds further.

On the upside, a better-than-expected PMI print could help GBP/USD recoup some of its recent losses, with potential resistance being provided initially by the 50% Fibonacci at 1.2643 and then the 38.2% Fibonacci at 1.2676.

Conservative leadership contest could be key for sterling outlook

However, any positive momentum is likely to be temporary until at least the Conservative leadership contest is over. Conservative party members will get to choose between former foreign secretary Boris Johnson and current foreign secretary Jeremy Hunt as their next leader, with the outcome to be revealed on July 22.

Both candidates, who are fighting to replace Theresa May as prime minister, have said they will not rule out the possibility of a no-deal Brexit on October 31, when the current extension for leaving the EU expires. But Hunt has adopted a somewhat softer stance than Johnson on a no-deal scenario, and given that the EU would much rather negotiate with him than Johnson, the only prospect for a relief rally in sterling in the short term is a surprise win by Jeremy Hunt to become the next prime minister. Otherwise, the chances of the pound’s fortunes improving before the October 31 deadline appear very little.


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Source: XM

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