U.K. Double Dip Deepens

Why is the U.K.’s Q2 preliminary GDP release important?

Hold up, let’s start with why the GDP report is important in the first place yo! GDP, which is short for gross domestic product, is an indicator of a country’s economic performance. Traders pay close attention to this figure because it acts as the report card of an economy.

In the U.K., the preliminary GDP or initial GDP estimate offers the first glimpse on whether their economy did well or not during the quarter. As such, it usually has the strongest impact on price action.

In particular, this Q2 2012 GDP figure would also reveal how deep the U.K. is in its current slump. Recall that the U.K. economy contracted by 0.3% in the previous quarter, after shrinking by 0.2% in Q4 2011. The recent release has significant implications on the U.K. central bank‘s monetary policy and whether they need to ease further or not.

Cool beans! How did the actual results turn out?

The actual GDP figure showed a whopping 0.7% contraction, which was worse than the consensus of a mere 0.2% dip. This buries the U.K. much deeper into their worst double dip recession in nearly five decades! Not only did this mark the third consecutive quarter of economic contraction, but it was also the U.K. economy’s weakest economic performance in three years.

Components of the report showed that the downturn in the construction sector was mostly to blame for the drop in GDP, although other industries such as manufacturing, services, transportation, storage and communication also posted declines.

The slight increase in consumer spending, spurred by the extra holidays in June for the Queen’s Diamond Jubilee, wasn’t enough to make up for those huge losses in other economic sectors.

Egads! What will the BOE and the U.K. government do now?

Three straight quarters of negative growth is no laughing matter, so the U.K. government could end up looking into the IMF‘s suggestion of shifting focus from austerity to growth to combat its economic contraction. What this means is that Prime Minister David Cameron may have to bail on the U.K.’s current belt-tightening plans, which has been described as the biggest budget squeeze since World War 2.

Recall that earlier this month, the IMF said that the U.K. will have to loosen policy further and ease up on its austerity measures if growth doesn’t pick up by early 2013. But the way I see it, whether Cameron agrees with this or not, it’s likely that the Bank of England will keep monetary policy easy. After all, the U.K. is going through the worst double dip recession in 50 years.

As David Tinsley, an economist at BNP Paribas put it, “the U.K. economy is still very fragile and proactive policy measures will continue to be needed to put in place.” No wonder many are expecting to see a 25-point rate cut and another 50 billion GBP in asset purchases by the end of the year!

Uh oh. What does this mean for the pound?

It’s elementary, my dear Watson! Elementary fundamentals, that is! When a country’s current or future economic outlook is good, its currency should strengthen. On the other hand, if its economy is doing badly, the currency should weaken.

Seeing as the latter is the case with the U.K., it’s no surprise that the pound was sold off so strongly after the GDP results were released. GBP/USD fell almost 90 pips after the report was published as traders reacted negatively to the disappointing figures.

GBPUSD

Even though the pound managed to hold its ground thanks to yesterday’s relief rally, we can’t rule out further losses in the future. Traders could very well price in prospects of BOE easing later in the year.

Now that the markets are in risk off mode and attention has shifted away from QE3, traders are no longer afraid to buy up the safe-haven USD. For now, it seems that the path of least resistance for GBP/USD is downwards.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>