EUR/GBP pulls back as Eurozone business activity contracts, UK services gain momentum

• The EUR/GBP pair retreats on Thursday, snapping a three-day rally to trade near 0.8420 during the American session.
• Weaker-than-expected Eurozone PMI data increases pressure on the Euro.
• UK services activity shows signs of recovery, while inflation jumps to 3.5% in April, reducing the likelihood of a near-term BoE rate cut.

The EUR/GBP cross edges lower on Thursday, retreating after a three-day rally to trade near 0.8420 at the start of the American session as investors digest a mixed batch of economic data from both sides. The Euro (EUR) is under modest pressure following weak Eurozone Purchasing Managers Index (PMI) figures, while the British Pound (GBP) holds relatively firm after the United Kingdom's (UK) inflation unexpectedly accelerated in April.

The flash HCOB Eurozone Composite PMI fell to 49.5 in May from 50.4 in April, missing market expectations of 50.7. This decline was primarily driven by a sharper downturn in the services sector as the Services PMI dropped to 48.9 from 50.1, undershooting forecasts of 50.3. In contrast, the Manufacturing PMI rose slightly to 49.4 from 49.0, topping expectations of 49.3.

The softer PMI figures reinforce concerns about a fragile recovery in the Eurozone, pressuring the Euro and strengthening the case for a European Central Bank (ECB) rate cut in June. Markets now see a roughly 90% chance of a 25-basis-point cut at the ECB's June 5 meeting but have priced in only one more reduction for the rest of the year, suggesting that the deposit rate could bottom out at 1.75%, according to Reuters.

Adding to the pressure, Belgium's central bank governor, Pierre Wunsch, said the ECB may eventually need to cut rates to "slightly below" 2% as ongoing global trade tensions pose downside risks to both inflation and growth.

Meanwhile, in the UK, the S&P Global UK Composite PMI rose to 49.4 in May from 48.5 in April, indicating a slight easing in the business downturn. The services sector showed marginal recovery as the Services PMI rose to 50.2 in April from 49 in March, beating market expectations slightly. The manufacturing sector continued to struggle with its PMI falling to 45.1 in April from 45.4 in March.

The Office for National Statistics (ONS) reported on Wednesday that annual inflation rose sharply to 3.5% in April, up from 2.6% in March and well above market expectations of 3.3%.

The expansion in the services sector, combined with hotter-than-expected inflation, could give the Bank of England (BoE) reason to hold off on cutting interest rates at its next meeting. At the same time, the contraction in the manufacturing sector highlights underlying weakness in the UK economy, meaning the BoE is unlikely to move aggressively in either direction and could hold the interest rate unchanged in the near term.