How Did the Markets
React?
Although today’s UK manufacturing PMI release was
marginally weaker than expected, fixed income and FX markets reacted more to the
price component of the release rather than the headline figure. Output prices
gained while input prices fell for a third consecutive month as manufacturers
passed on the cost increases they incurred in previous months. Additionally,
export orders rose from September, quelling fears that a slowdown in the
US may seriously impact
export growth in the UK, which was likely an attractive
feature of the PMI report. However, the greater issue at hand, especially for
the FX markets, was the increasing possibility that the Bank of England will
hike rates next week to 5.00 percent from 4.75 percent. Hawkish comments made
late yesterday by BOE Governor Mervyn King spurred further speculation of
monetary policy tightening, as Mr. King noted that “inflation is a little bit
above target and there doesn’t seem to be a great deal of spare capacity.”
UK equities, on the other hand, paid
absolutely no attention to the economic data and continued to track higher from
yesterday’s close primarily on the back of a strong mining sector.
Bonds – UK 10-Year
Gilts
Bond prices in the UK were quick to
react to the price component of manufacturing PMI, which showed that output
prices gained while input prices fell for a third consecutive month, signaling
that manufacturers are passing on the cost increases they incurred in previous
months. This highlights the Bank of England’s fears of second round effects on
price pressures and boosts the likelihood of a rate hike next week. However, the
gain in 10-year gilt yields was short lived, as prices turned higher about an
hour after the release. While the overall price change was insignificant at no
more than 2 basis points, bond traders may have been looking at the fact that
the overall new orders component of PMI declined while exports rose, indicating
that domestic demand remains weak and manufacturing growth may still be
dependent upon foreign demand.
FX –
GBP/USD
Cable’s reaction to the
UK manufacturing PMI data was
the most “correct” of all the UK markets, as GBP/USD pushed higher
immediately upon release. However, appreciation of the pair was meager as price
quickly backed down from resistance at the 1.9100 level. Similar to fixed income
markets, the Pound acted more in accordance to the price component of
manufacturing PMI, which showed that output prices gained while input prices
fell for a third consecutive month, signaling that manufacturers are passing on
the cost increases they incurred in previous months. This highlights the Bank of
England’s fears of second round effects on price pressures and improves the
likelihood of a rate hike next week. However, gains for the GBP/USD pair may be
limited as the possibility of 5.00 percent rates in the UK should be
priced in already, as Cable has rallied more than 500 points over the course of
the past three weeks. Should the BOE decide to wait until December to pursue
policy tightening, the UK currency could be in for very
sharp declines.
Equities – UK FTSE 100
Index
While UK equities
pursued gains today, it had little to do with economic data out of the country.
Nevertheless, the equity market reaction was technically “incorrect” given the
headline data, since a drop in UK manufacturing PMI would infer that
the sector may be slowing. Furthermore, this would not bode well for the shares
of these companies, as profits would subsequently drop on weaker output and
higher costs.
The FTSE 100 surged higher as
soon as the markets opened, and by the London afternoon the index extended its early
gains to trade 22 points, or 0.4 percent, higher at 6,151.2. The gains were led
by strong showings in the mining sector, with Xstrata up 2.8 percent to 23.02
pounds while Lonmin added 2.4 percent to reach 29.71 pounds. BHP Billiton also
performed well, gaining 2.1 percent to hit 10.32 pounds while Rio Tinto rose 1.4
percent to £29.32. Additionally, equity markets took kindly to news that Cairn
Energy would raise about 618 million pounds from the sale of 30.5 percent of its
Indian operations. Those proceeds will be used to fund ongoing operations, but
the company said that some will be returned to shareholders as well. Shares of
the oil exploration company jumped 1.4 percent to 17.79 pounds.
