Sterling jumped on Wednesday after data showed growth in Britain's dominant services sector hit a three-month high in March, soothing some fears over the health of the economy after manufacturing and construction surveys showed growth slowing. The pound, which had lost over 1 percent of its value against the dollar since Monday, bounced back after the purchasing managers' index (PMI), rising to as high as $1.2497 in afternoon trade in London. That left it up almost half a percent on the day but down around 0.6 percent on the week.
Though the services PMI came in stronger than expected, hitting 55.0, up from 53.3 in February and beating all forecasts in a Reuters poll, taken together with the manufacturing and construction surveys, the data suggested Britain's economy has probably cooled from its strong growth of late 2016. And there were other warning signs. Services companies raised their selling prices at the fastest pace since 2008, a sign that inflation may rise more than the 3 percent expected by many forecasters this year. Businesses hired people at the slowest pace in seven months.
"Sterling received a lifeline on Wednesday," said FXTM Research Analyst Lukman Otunuga. "(But) although economic data ... continues to display post-Brexit resilience occasionally, the possibility of growth decelerating in the first quarter of 2017 may weigh heavily on sentiment." The pound also climbed against the euro, trading up 0.5 percent at 85.32 pence.
Most traders and analysts said the main driver for sterling would continue to be how negotiations over the terms of Britain's exit from the European Union play out. Britain must stop pressing for immediate parallel talks with the European Union on a post-Brexit free trade deal, EU chief negotiator Michel Barnier said on Wednesday, and first agree on withdrawal terms.
"With the European Union setting out its 'red lines' for the Brexit negotiations and emphasising how the divorce terms must be agreed before striking any new trade deals, a rocky road may lie ahead," said Otunuga. "Brexit fatigue" may make the currency less sensitive to political developments, however. Sterling has fallen almost 17 percent against the dollar since June's vote to leave the EU.
Many economists say political uncertainty surrounding Brexit, as well as faltering wage growth, will prevent the Bank of England from tightening monetary policy anytime soon despite accelerating inflation, which could act as a cap on sterling. "The BoE cannot be seen to be cavalier when it comes to its inflation target, but periodic reminders of this fact aside, current economic trends reinforce our conviction in the BoE's sustained tolerance of above-target inflation," wrote BNY Mellon currency strategists in a research note.