British Pound Humbled as UK Slides into Double-Dip Recession
The British Pound has had a very interesting past twelve months. On April 28, 2011, the GBPUSD traded to its yearly high at 1.6745, but within six months, the pair had sunk to a new yearly low at 1.5270 on October 6. While the GBPUSD traded back towards 1.6000 in the fall, the start of 2012 was rocky for the Sterling, which saw the cable sink to a two year low of 1.5234 on January 13, 2012.
Recently, on the back of better than expected economic data, Bank of England policymakers began to shift away from their aggregate neutral if not dovish stance. Adam Posen, one of the two remaining doves calling for more quantitative easing on the Monetary Policy Committee, dropped his bid for looser policy. Traders have taken this shift in the MPC as a sign that rates will soon rise, and accordingly, have bid up the British Pound. The GBPUSD rose to a fresh yearly higher at 1.6170 earlier today in hopes that the first quarter growth reading for the United Kingdom would confirm the BoE’s outlook; instead, it now appears the British economy has dipped back into a recession, muddling the British Pound’s recent bullish momentum.
While there have been some improvements in the British economy over the past few months, the first quarter preliminary growth reading did not show it. On a quarterly basis, growth contracted by 0.2 percent after contracting by 0.3 percent in the fourth quarter of 2011; on a yearly basis, growth remained unchanged in the first quarter after growing by 0.5 percent in the fourth quarter of 2011. Of course, it is important to make note of the consensus forecasts, because those are the readings that helped propel the British Pound to fresh yearly highs against the US Dollar: quarterly growth was expected at 0.1 percent; yearly growth was expected at 0.3 percent. When considering the United Kingdom’s growth relative to that of the United States the past few quarters – 3.0 percent annualized in the fourth quarter of 2011 – the British growth picture looks even more dismal.
Thus, not only did the economy contract, growth was much worse than what was expected. While the British Pound fell across the board on the data release, the big question now is whether or not the BoE will reassess their outlook, and whether or not there will now be another liquidity injection in the coming months. Recent inflation data and other gauges of economic output suggest that more easing is possible.
Overall growth aside, inflation has been the biggest issue for BoE policymakers. Certainly the government’s fiscal austerity measures have helped ease price pressures, but beyond what has been already implemented, it appears that inflation won’t come off any further given the measures in place. In fact, after year-over-year price pressures peaked at 5.2 percent in September, they fell to their lowest level in February since November 2010. But inflation has already started to tick back up: the same gauge rose to 3.5 percent in March. A higher inflation outlook is one of the only impediments the BoE will have to implement more easing.
Beyond recent inflation data, trade data suggests that the renewed appeal of the Sterling over the first few months of 2012 has impeded economic growth prospects. Although only data from January and February is available, we do note that in both January and February import growth outpaced export growth. In fact, as exports dropped by 2.0 percent in February, imports rose by 0.2 percent. Similarly, while exports fell by 0.6 percent in January, imports expanded by 1.4 percent. Considering the Sterling’s performance against the United Kingdom’s largest trading partners in January and February, the recent trade data is surprising: the Sterling fell by 0.39 against the Euro in January and February; it lost 1.28 percent to the Swiss Franc; though it appreciated 2.35 by against the US Dollar.
A weaker Sterling is exactly what the British economy needs, however, especially against the Euro and the US Dollar. By further boosting exports, further investment could enter the country in order to help manufacturers meet foreign demand for British goods. Case and point: industrial and manufacturing production contracted by 2.3 percent and 1.4 percent, respectively, in February.
With growth slowing to the point where the economy teeters on the edge of a double-dip recession, it remains to be seen whether or not the BoE sticks to its recent hawkish rhetoric.Yesterday, MPC member David Miles said that his vote for more quantitative easing “looks vindicated” in light of recent data and the first quarter growth reading suggests this may be true. Accordingly, it is likely that the BoE backpedals away from their recent hawkish commentary. Just last week, it looked like the Sterling was set to be one of the best performing major currencies through the first half of the year; now, the Sterling is a bit more humbled, and so too are the BoE’s hawks.
Forecast: GBPUSD to 1.5600 by the end of June
--- Written by Christopher Vecchio, Currency Analyst
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