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New U.S. data points to growing stagflationary conditions.
The Pound to Dollar exchange rate (GBP/USD) rose to a high of 1.3580 on Thursday following data prints that confirmed the uncertainty of recent months is starting to impact businesses.
The ISM services PMI fell 1.7 points in May to 49.9, reflecting notable downswings in business activity and new orders, which were softer than the consensus forecast for 52.0.
A reading below 50 is consistent with a contraction in activity. The decline was driven by a sharp drop in new orders and stagnation in business activity, driven by ongoing trading tensions.
Worryingly, the prices paid indicator ascended somewhat further toward post-pandemic highs, pointing to building inflationary pressures, complicating the Federal Reserve's ability to respond to any economic slowdown with interest rate cuts.
"May's ISM services PMI points to worsening fallout from the tariffs on service sector activity, alongside further intensification of cost pressures that have been gathering steam for some time," says Jonathan Miller, an economist at Barclays.
Rising inflation and a slowing economy point to stagflationary conditions. Typically, the Federal Reserve would be expected to react to a slowing economy by cutting interest rates. However, if inflation is rising, it can't do that, for fear of exacerbating inflation.
"The estimates show some "stag" and some "flation," with activity and new orders both plunging and the prices paid index reaching heights not seen since the post-pandemic supply chain crunch," says Miller.
"The May ISM Services PMI sent a stagflationary signal, reinforcing the case for defensive positioning," says BCA Research.
Stagflation is detrimental for U.S. businesses and consumers, who will have to wait for inflation to fall before the Fed is able to come to the rescue with lower interest rates.
"The U.S. Dollar weakened on Wednesday after a disappointing batch of economic data cast fresh doubt on the strength of the US economy and the pace of job creation
Also released on Thursday was an ADP private payrolls report that showed the U.S. economy added just 37,000 jobs in May, the lowest in over two years and far short of market expectations for 115,000.
The data comes ahead of Friday's all-important U.S. jobs report, where a soft reading could see the USD limp into the weekend and GBP/USD print new 2025 highs.