A while back I pointed out that the referendum on Scottish independence was likely to impact trading in the British pound (NYSEARCA:FXB). I have wavered a bit on the assumption. However, as the big date approaches, I am more firmly assuming that the incremental uncertainty introduced by the referendum will at least prevent the British pound from rallying on any good news. Indeed, sentiment has likely turned to emphasize negatives over positives.
The persistent weakness in the pound can be observed with the recent sharp comeback by the euro (NYSEARCA:FXE) against the pound, and the extremely sharp decline in the pound versus the U.S. dollar since mid-July (granted, the dollar has been strong against almost every currency). The pound managed a small uptick in response to a stellar August performance from UK services and construction, but the jump was fleeting. The report also contained a red flag for manufacturing which is highly dependent on international economic activity. So, the good news is that the domestic economy is doing quite well, but events in Europe are threatening to derail the UK's overall growth trajectory.
CurrencyShares British Pound Sterling ETF is actually DOWN for the year now!
The services sector is now leading the way in the UK economy:
"The weighted average Output Index from the three Markit/CIPS PMI surveys rose from 59.0 in July to 59.8 in August, its highest since November of last year. The pace of growth has now accelerated for two successive months, pushing the average index reading for the third quarter so far to the highest since the fourth quarter of last year, albeit by only a small margin."
And the key kicker:
"The sustained elevated PMI readings therefore suggest the UK is on course to see another spell of strong economic growth in the third quarter, similar to the 0.8% expansions seen in each of the first two quarters of the year."
The report goes on to point to increasing strength in construction led by housing, commercial building, and civil engineering:
"Growth also accelerated in the smaller construction sector, rising to the fastest since January and registering the fourth-largest monthly improvement seen since 1998. The headline index jumped from 62.9 to 64.0. While house building activity provided the mainstay of the sector's upturn, commercial building and civil engineering also continued to grow at historically high rates."
Manufacturing is the big concern and here is where softness in Europe comes into play. With production growth declining for the fourth month in a row, Markit projects that overall output could be stagnating by the fourth quarter.
A mixed picture: services and construction are as robust as ever while manufacturing is playing the downer
Markit blamed the strong British pound and economic sanctions on Russia as impediments for the manufacturing sector. Neither factor is significant for the domestically oriented services and construction sectors.
The implication of these mixed results, well-noted in the Markit report, is that Carney's seeming confidence in rates going up "sooner than the market expects" is likely being called into question by market participants. The upshot on the currency side of the equation is that Carney can feel more comfortable about any strengthening impact from the first rate hike.
Sudden weakness in the Japanese yen (NYSEARCA:FXY) allowed me to pull out of my bullish bet on GBP/JPY at a profitable level. I am still long the British pound, but much less so now. If my guesses are correct, resolution on the referendum on Scottish independence could (should?) spark a relief rally in the pound. If independence wins, some kind of announcement on what happens to the British pound relative to Scotland could also spark a relief rally. Either way, I plan to stand down again from the British pound and take a more neutral stance by the end of this month or so.
Be careful out there!
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