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The UK economy looks to have firmed after the budget.
The pound to euro exchange rate (GBP/EUR) rose above 1.14 after the UK reported consensus-beating wage data on Tuesday.
However, it was a solid PMI report, released mid-morning, that set pound sterling into its stride.
S&P Global reported its three PMI surveys of the private sector economy showed growth accelerated in December. The Services PMI rose to 52.1 from 51.3, beating estimates for 51.5.
“December’s flash PMI surveys brought welcome news on faster economic growth at the end of the year, with businesses buoyed in part by the post-Budget lifting of uncertainty,” says Chris Williamson, Chief Business Economist at S&P Global Market Intelligence.
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Manufacturing PMI read at 51.2, up from 50.2 and ahead of consensus at 50.2.
The Composite PMI – which attempts to give a sense of activity in the broader economy – read at 52.1, up from 51.2 and ahead of a consensus estimate for 51.4.
Encouragingly, the pick-up was driven largely by the sharpest rise in new business for 14 months.
The pound-euro conversion rose to a high of 1.1416 following the data, having been as low as 1.1373 earlier in the day.
Sterling’s advance reflects the market’s view that a recovery in business activity into year-end will lessen the need for the Bank of England to lower interest rates in the coming year.
In fact, the Bank of England will sit up and take notice of the report’s finding that stronger inflationary pressures were signalled at the end of 2025.
Input costs increased sharply and at the fastest pace since May.
Above: Cost pressures are elevated and rising again.
If price pressures are rising again the Bank of England will be constrained in its desire to lower rates, for risk of stimulating inflation further.
That being said, the report also indicated pressures on jobs remained: Cutbacks to staffing numbers persisted with employment decreasing for the fifteenth successive month, said S&P Global.
This morning, the ONS reported another monthly drop in UK payrolls, while the unemployment rate rose to 5.1%.
Economists say falling employment will bring down wage increases, which is disinflationary. The Bank will therefore feel it can get away with a 25 basis point cut this Thursday.
However, next year will be a challenge: how will the Bank navigate firm above-target inflation and falling employment?
The answer will have a major bearing on sterling: the currency will be firm if rates don’t fall too much further. However, if the Bank does cut on numerous occasions in response to a weakening labour market, GBP/EUR can fall further towards 1.11.
