Sterling shines as UK GDP beats expectations
29/Apr/2013 • Currency Updates•
Sterling was the star of FX markets last week. A rare positive surprise in first-quarter GDP on Thursday sent the currency sharply higher against just about every other major currency, as traders scrambled to priced in the increased likelihood of no further QE from the Bank of England for the time being. Beyond currency markets, investors shrugged of the negative tone in global macroeconomic news by sending equities up 2% for the week, recovering all of the previous week’s losses and flirting with their cycle peaks. Markets are clearly taking a sanguine view of the global slowdown; for now we agree with that view, eurozone excepted, though we look to next week’s payroll data out of the US to confirm our stance.
All eyes were on the first-quarter advance release of GDP growth numbers, and investors were not disappointed. The numbers deliver the kind of positive surprise that has become quite rare worldwide over the past few weeks. The economy grew 0.3%, or 1.2% on an annualized basis, rather than the flat to slightly down number that the consensus (and ourselves) had been expecting. Traders lost no time and reacted by sending sterling sharply higher. We think the market reaction is warranted. The GDP numbers, together with the announcement of a beefed-up lending scheme address at SMEs, means that the MPC will likely delay any increase in the Gilt purchase target at least until well into the summer. We have therefore revised our forecasts for sterling upwards against most major currencies.
Data out of the eurozone provided a stark contrast to the moderately positive tone in the UK. The critical PMI surveys of business managers all fell further into levels consistent with a sharp economic contraction in the order of 1.5%-2% annualized. The German index fell clearly below the 50-line. Our view that the eurozone economy is in real trouble is therefore vindicated. We think that the ECB can no longer ignore the disastrous state of the economy, and will be forced to cut rates at next week meeting; however, the ability of European policymakers to ignore reality should not be underestimated. At any rate, the monetary transmission mechanism is essentially broken, so a cut would have more symbolic value than anything else. There are, however, some faint hints that the failure of austerity is starting to be acknowledged, as European Commissioner Barroso suggested that public tolerance of senseless pain is reaching its limit, and Spain was tacitly given additional time to reach the chimerical 3% deficit target. We have to see more explicit rejection of austerity before we change our negative view of the euro. However, German officials seem to be as stubborn as ever on the issue.
The US GDP report was a mirror image of its British counterpart. Although the headline number of 2.5% looked good on the surface, most strategist (ourselves included) had expected a stronger bounce from the previous quarter’s very low growth of 0.4%. Federal Government spending took another tumble in the quarter, led again by a large fall in defence expenditure. The negative surprise was somewhat offset by the positive news on consumer demand, which rose a healthy 3.2% in spite of the tax increases that kicked in in January. Austerity, in the form of the sequestration cuts, is the main headwind faced by the US economy. We are maintaining our expectation of economic growth in the range of 2.5-3.5% for now, but next week’s payroll report will be even more critical than usual as a timely check on the health of the US labour market and consumer incomes.