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After plunging back into recession in the first quarter of 2012, UK data at the start of the second quarter hasn't been particularly encouraging. Today the manufacturing PMI survey for April was weaker than expected at 50.5 down from a revised 51.9 in March, which was the lowest level since December. The biggest decline was in the export sector, as the UK's largest trading partner, the Eurozone, suffers from its own economic and sovereign woes. However, what was worrying is that new orders to Asia and the US also fell sharply, which is concerning as they may not be able to balance out the weak growth coming from Europe.

Could the BOE expand QE?

This report is the first of three April PMI surveys released over the coming days and the results for the construction and services sectors will also be closely watched. The manufacturing sector has been weak in recent months and makes up 10% of the UK economy, however, the services sector, which makes up 70% of the economy, is also under some stress and consumer confidence remains low. This data makes the outcome of next week's Bank of England meeting less clear-cut. After noted dove Adam Posen shifted his stance to neutral at the April BOE meeting more QE is now not a given, however the weaker tone to UK economic data could make some members a little worried that the UK economy will need more stimulus in the coming weeks and months.

The pound rallied strongly on a broad-based basis post the news that Posen had shifted his stance at the BOE. However, next week we will find out just how hawkish the Bank truly is. If it sounds worried about the growth outlook then we could see the prospect of more QE come back on the table potentially causing the pound to come off sharply. The BOE has said before that it expects the UK economy to remain weak until the second half of this year, however with the Eurozone debt crisis still raging and signs that the US economy may not be as strong as we thought a couple of months ago, it's hard to see where growth in the second half of this year will come from. Thus, the pound could be on weak foundations if it has rallied based on expectations of a hawkish BOE, as this may not tally with the need for BOE intervention in the UK economy.

China's cloudy outlook

In contrast to the UK, official Chinese PMI data for April was stronger than expected at 53.3 from 53.1 in March. This survey has diverged from the HSBC version, which remains in contraction territory below 50. Thus, the outlook for China is incredibly cloudy as these two signals are giving differing results. However, based on the official figure alone, this has expanded for five consecutive months and suggests that the economy may have bottomed in the first quarter of this year.

More to come from the RBA?


The China data wasn't enough to help the Aussie, which dropped sharply after the RBA cut interest rates by 50 basis points. The market had priced in about 30 basis points of tightening, so this was a surprise to the market. The focus now is on what the RBA will do next. The statement that accompanied the cut did not give too much away, although the RBA said global growth had moderated, it also said that a deep downturn was not occurring. It sounded more worried about downside risks to inflation than it did about growth, however, although it expects inflation to be lower than it originally expected, it still forecasts prices to remain within its target 2-3% range. It mentioned that the Aussie remains high even though the terms of trade have deteriorated, thus it could cut further, however, we think there may be only one cut in the coming months bringing the target rate down to 3.5%. Thus, we don't believe that the RBA is embarking on a prolonged cutting cycle, unless there is an external shock that threatens the Australian economy and the trajectory for inflation.

Market moves:


The dollar is weak today, although it has started to claw back some losses mid-way through the London session. The pound was initially hit hard post the PMI data, however it clawed back gains versus the dollar fairly quickly and remains around the 1.62 zone. We believe GBPUSD is a sell on strength as the market re-assess just how hawkish the BOE can be given the outlook for UK growth.

The pound was weaker versus the euro. EURGBP has clawed back 50 pips worth of losses in the last 24 hours and is currently testing 0.8180 resistance. We continue to think the pound will do better vs. the euro than the dollar, and look to sell this pair on any strength above 0.8200 to look for a grind lower towards 0.80 in the coming weeks.

The Aussie dropped 100 pips immediately after the announcement from the RBA, but found good support around 1.0310. Below here opens the way to 1.0250 and then towards the early April lows of approx. 1.0225. However, it is looking fairly oversold, so could be due a pullback. The fact that the RBA mentioned the strength of the currency, suggests that the Bank believes there is further for the Aussie to fall and still remain in line with fundamentals. However, the stubbornly weak dollar could thwart Aussie bears.

We get US ISM manufacturing data this afternoon at 1500 BST. Most of Europe is out on holiday today, so things could be quiet in the London session until then. The ISM is a key data release that paves the way to Friday's payrolls. A weak reading increases the chance of QE and could weaken the dollar even further.

The euro recovered some of yesterday's losses today as the dollar came under pressure and EURGBP benefitted from the GBP weakness post the PMI data. 1.3220 remains key support while 1.3280 is resistance ahead of a well-noted 1.33 barrier. This is a key resistance level that has generated a lot of selling interest from the market, so it will take a monumental push from the bulls to get EURUSD above this level. Potentially weak US economic data/ QE expectations from the Fed could do it, but we think this pair is fairly range-bound today and we believe the election risks in France and Greece this weekend could cause sentiment towards the euro to sour later this week. 1.3050 remains the key support level of note. As mentioned, Europe is out on holiday today, but anti-austerity protests are planned in Spain and France. Any negative headlines could weigh on the euro.

Stock markets are quiet and with Europe out US indices are expected to open slightly lower.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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