There was a shock to the system today, as the pound endured the currency equivalent of falling into an ice cold lake. GDP figures released this morning showed that the British economy contracted by 0.5% in the three months through December.
Although this was a first estimate, the realisation at just how poor these figures were (market forecast was a full percent higher) caused the pound to sink across the board. It fell over 2 cents against the US dollar and a cent over its euro neighbour in just a matter of minutes.
With Johnson out, the incumbent Shadow Chancellor Ed Balls will be smacking his lips at the prospect of getting stuck into Tory manifesto, hounding Cameron and Osborne for “complacently congratulating themselves” for securing the economic recovery back in the Autumn and urging the government to pause and "rethink" its deficit-reduction strategy.
Indeed it appears the back slaps may have been a little hasty. With the economic recovery grinding to a halt, arguments for an interest rate rise will surely have gone into full retreat. Adam Posen is another man who probably wore a wry smile on his face today. His dovish stance is likely to have attracted some followers among the MPC members, although an accompanying vote for QE is less likely with inflation as high as it is.
The question is, just how much will this new data affect policymaker’s decisions? It’s worth noting, however excitable/nervous the market gets over this figure, it’s only estimated data - I’m not expecting the Bank of England to fully reassess the strength of Britain’s economic recovery at this stage. We did also see a staggeringly bleak December weather-wise, and history tells us that the UK isn’t overly competent in the snow. How much did this adverse weather affect our growth? Osborne, understandably, thinks a lot.
What this data has done is to mark a substantial step back for Britain, and it could force downward revisions to both 2011 and 2012 growth forecasts. Sterling’s forecasted turnaround in trend against the euro also looks to have taken a step back. So the question now is just how long will this hangover last?
Duncan Higgins
Senior Analyst – Caxton FX
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