After the dollar, the pound was the currency that most appreciated last year as the BOE was among the most aggressive rate hikers among the major central banks. But, the higher the rates go, the more they can come down. Now the question is whether the gains can be maintained.
That requires a good understanding of why the pound got so strong in the first place. The higher inflation rate – the highest among the developed world – forced the BOE to raise rates, not solid growth in the economy. In fact, a large contingent at the Bank of England during that period were opposed to hiking precisely out of concerns for the weakness of the economy.
If the UK economy falters as many fear, and high interest rates are to blame, then the BOE could switch to be among the fastest rate cutters of major central banks. Thus, there is a lot of attention on how the economy has been performing. Especially because of a quirk of UK inflation.
Last year, despite the high inflation, average pay in the UK rose in real terms. That could have helped keep UK consumers resilient in the face of the economic challenges. A tight labor market gave workers leverage to ensure wages kept pace with inflation. But that also increased the cost of labor, while competing economies saw real wages falling. This could leave the UK economy less competitive, hurt manufacturing, services and the key banking industry, and tip the economy over into a recession.
In the third quarter, the UK reported negative quarterly growth of 0.1%. Just barely under the line. To make matters worse, though, October (the first month of Q4) saw a monthly decline in GDP of -0.3%. That could be setting the stage for a second consecutive quarter of negative growth for the country, meaning it would fall into a technical recession. Keeping rates high will be a hard slog for the BOE hawks if the economy keeps showing negative growth.
Thus, the possibility of substantial relief for the pound if November monthly GDP is positive and beats expectations. On the other hand, a negative monthly GDP would make it really hard to revert the trend in the final month of the year, and it could mean the markets start to price in the UK being in a recession. That could pull forward expectations for the first rate cut by the BOE, and drag down gilt yields, hurting the pound in the process.
UK November GDP is expected to come in at +0.1%, a substantial improvement over the -0.3% of October. But that wouldn’t be enough to hold the rolling three-month average in the green, as it is forecast to tick down to -0.1% from 0.0% prior.
Where is the growth coming from? The surprising resilience of the UK manufacturing sector, which could provide additional support if the other data point being released tomorrow beats expectations. But a miss here could also leave markets worried about the future strength of sterling. Monthly UK manufacturing production is expected to jump back to 0.3% growth compared to -1.1% prior.
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- Source: https://www.orbex.com/blog/en/2024/01/uk-gdp-manufacturing-and-avoiding-a-rate-cut
