Color on UK Surprise

The economic surprise of the day was UK industrial output, which fell 1.2% instead of rise the 0.4% the consensus expected. First let's look at the source of the disappointment and second, implications.

Weakness was seen in all three components of UK industrial output--mining, utilities and manufacturing. Mining and quarrying fell 2.8% and this seemed largely the result of seasonal maintenance. Utility output fell 2.1% and this seemed largely a function of weather.

That leaves manufacturing. It had been expected to have risen 0.6% and instead was flat. The Jan series was revised to 0.9% from 1.0%. Here too the weakness was widespread. Of the thirteen manufacturing industries, 9 contracted. These include furniture, chemicals, artificial fibers and recycling.

The decline in utilities and mining do not appear so significant, the stalling of manufacturing is a bit more problematic and would seem to point to genuine economic weakness.

Leaving aside the hawkish minority on the BOE's MPC, market observers do not expect the BOE to hike rates tomorrow, however the strong service sector PMI had emboldened market expectations for a May hike. The OIS curve suggests a 60% chance of a hike discounted for May. This seems relatively high and does not appear to have changed very much with today's disappointment, while the June short sterling futures rallied and the implied yield fell 7 bp from yesterday's low to today's high.

Sterling finished the NY session on new session highs yesterday and enjoyed follow through buying in Asia and in early Europe before the data. It has now found support near $1.6250. Look for new near-term highs with test on $1.6400 in the next day or two.