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Second Quarter GDP will Highlight Fragility of British Economy, Hurt GBP

Second Quarter GDP will Highlight Fragility of British Economy, Hurt GBP

Christopher Vecchio, CFA, Senior Strategist
Second_Quarter_GDP_will_Highlight_Fragility_of_British_Economy_Hurt_GBP_body_Picture_5.png, Second Quarter GDP will Highlight Fragility of British Economy, Hurt GBP

Fundamental Forecast for British Pound: Bearish

The British Pound has a modestly strong week, even though it finished in the middle of the pack among the majors. Of the three currencies that outperformed the British Pound, the Euro, the Swiss Franc, and the Canadian Dollar, gains against the Sterling were capped by no more than +0.16%. When comparing the Sterling to the worst performing majors, the Australian Dollar and the Japanese Yen, gains were that much more impressive, as the GBPAUD and GBPJPY rallied for +1.46% and +1.65%, respectively.

We find that this continues to be a knock-on effect of the commentary provided by Bank of England Governor Mervyn King, rather than a discernible shift in the British Pound’s underlying fundamentals: Governor King had previously indicated that rate cuts might not stimulate the economy, and as such, any headwinds to the British Pound related to accommodative monetary policy have thus been brushed aside in the short-term. Yet despite this, we believe that the British Pound has a bearish fundamental outlook for the coming week, as it will become more evident that additional stimulus measures will be necessary in the coming months.

Overall, the data flow out of the British economy is very light next week: there are no particularly important events until Friday on the economic docket. But Friday’s docket offers up one of the most important releases for the British economy: the quarterly growth print. And it is due to this data that we hold a bearish outlook for the British economy.

According to a Bloomberg News survey, the British economy contracted by -0.5% in the second quarter, a marginal improvement over the -0.7% quarterly rate of contraction originally reported. Nevertheless, this would market three consecutive quarters of contraction for the British economy, and the fifth quarterly contraction over the past seven quarters; the British economy is very fragile indeed. Furthermore, on a yearly-basis, the second quarter revision suggests that growth only contracted by -0.6% versus the -0.8% contraction originally reported.

Although the revisions are expected to show that the British economy isn’t contracting as sharply as previously thought, the Bank of England still cut the economy’s forecasts this past week, with Governor King saying that growth would remain “subdued” in the near-term. This is despite the “erratic factors” that influenced weaker growth in the second quarter, as the Bank of England noted. But we must consider, as always, the bigger picture. Inflationary pressures have fallen in the United Kingdom, with the year-over-year Consumer Price Index holding below +3.0% for three consecutive months for the first time since October through December 2009. In light of these facts, alongside the continued streak of depressed growth in the United Kingdom, we believe that British Pound’s fundamental bull run may be stymied in the coming days and weeks, as speculation and chatter about more easing from the Bank of England will arise again. – CV

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