Preview - Mind the GDP gap, a vital two minutes for Sterling

November 1st 2011: Preview - Mind the GDP gap, a vital two minutes for Sterling

The relative strength of Sterling since last week’s EU Summit sends a very important message over how confident global funds and reserve managers are really feeling about the deal. Sterling’s ability to rally in the face of very weak domestic fundamentals is a clear vote of no confidence in the Euro and also the dollar. The UK currency has been able to distance itself from the Euro-zone crisis with capital inflows into the bond market and an increase in Sterling’s use as an international reserve currency despite fears surrounding the UK banking sector.

The latest UK data releases will be very important in determining whether this trend can continue in the short term. The UK economy desperately needs growth for the government’s economic strategy to work. Without growth, measures to cut the budget deficit will condemn the UK economy to recession and a very sharp decline in Sterling on the back of credit rating cuts.

Market headlines will inevitably focus on the third-quarter GDP data, although the PMI data will provide more insight into the UK economy given that it is forward looking and will pick up any recent deterioration. Very importantly, the PMI data is also released to insiders two minutes earlier than the GDP data and will trigger big market moves immediately ahead of the GDP release. If GDP growth is 0.5% or higher and the PMI index above 50, then Sterling will be set for further short-term gains. In contrast, any GDP release below 0.3% and PMI outcome below 48 would trigger a sharp reassessment of the UK and trigger heavy selling pressure. The most likely outcome looks to be higher than expected GDP and weaker PMI data which suggests that there will be a brief Sterling buying opportunity immediately after the PMI data as initial pessimism is reversed, but no real basis for sustained currency support.

After the shock contraction seen for the fourth quarter of 2010, markets have hit the target with their GDP estimates and are expecting a figure of 0.4% as an advanced reading for the third quarter. The latest NIESR data forecast a third-quarter gain of 0.5% which may suggest there is a slight upside bias to the data. It will be extremely important to watch government media briefings ahead of the release. If it is not a good report, there will be comments suggesting that the recovery was always going to be difficult whilst blaming the Euro-zone debt crisis. If the data is better than expected, there will be more upbeat comments suggesting that the UK is on the right path.

The trade component will be watched closely as there were sharply better than expected figures for the trade account and the current account data according to the latest releases. The trade deficit was at GBP8.8bn for August from an expected GBP8.8bn while the current account deficit for the second quarter was held to GBP2.0bn. This should primarily affect the second-quarter revision, but could have an impact on the third-quarter advance reading as well. There should also be some recovery from distortions in the second-quarter data.

Consumer spending dominates the data and a lacklustre reading looks likely. There is little chance of a significant contribution from the construction sector while investment is always erratic at best. Indeed, there will be important reservations surrounding the data quality.

The PMI is always an extremely important indicator given its sample base. For this month, markets are expecting a figure on the benchmark 50 level after a stronger than expected reading of 51.1 last month. October was the first time there had been a better than expected reading since February. If the UK index can hold above the 50 level, there will some palpable optimism that the UK can continue to distance itself from the Euro area in the short term, although in absolute terms there is unlikely to be much to celebrate in the data.

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