Wednesday, 26 January 2011

Sterling falls due to shrinking economy

26th January 2011
Good morning. Yesterday UK growth was expected at +0.5%. The actual figure was a DECLINE of 0.5%, raising the risk of a double dip recession in the UK. Sterling was hammered as a result, falling in a big way against all currencies. At 08:30am this morning rates are as follows:
  • GBP/EUR 1.1536
  • GBP/USD 1.5792
  • GBP/AUD 1.5816
  • GBP/NZD 2.0545
  • GBP/CAD 1.5731
  • GBP/CHF 1.4911
  • GBP/ZAR 11.163
  • GBP/JPY 129.57
  • GBP/NOK 9.0872
  • EUR/USD 1.3686

Sterling drops as economy shrinks

So what was the effect of GDP falling on Sterling exchange rates? The UK's economy suffered a shock contraction of 0.5% in the last three months of 2010, figures have shown. The figures are set to raise concerns over prospects for the economy, with large public spending cuts expected to come in this year. The contraction follows four straight quarters of growth.

The release is a first estimate for the quarter from the ONS and is subject to revision, but even so the figures were awful. The contraction took economists by surprise, as forecasts had been for growth of between 0.2% and 0.6%.

"This is a horrendous figure. An absolute disaster for the economy. We knew that retail sales were heavily affected and that services output would be weak, but the collapse in construction was a major contributor to the downside surprise," said Hetal Mehta from Daiwa Capital.

We have had a few GDP shocks with the economic turbulence of recent years. This one is high on the list. Even factoring in the snow effect, the gloomiest analyst predicted zero growth in the final quarter. The reality was a sharp fall in output. Not good news for those needing to buy currency with Sterling.

The effect on Sterling exchange rates

Sometimes figures are different than forecast, but not usually by such a huge amount. The result was the pound fell against all currencies, and against the Euro we are now in the €1.15's, and it was only a week ago rates were above €1.20.

The weak figures also highlight the dilemma facing the Bank of England, which needs to tackle above-target inflation but is reluctant to raise interest rates when the UK's economic recovery is still uncertain.

"The MPC [Monetary Policy Committee] must abandon any early interest rate rise until the recovery is more secure," said David Kern, chief economist at the British Chambers of Commerce.

Now there is much less chance of a rate hike in the UK, with Europe likely to raise their rates before us, there is not much to suggest we will see gains against the Euro in the coming weeks.


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