Improved GDP numbers will add to the growing confidence in sterling

Kathleen Brooks
ALL the signs are pointing to an upward revision to UK GDP growth this morning. The consensus among City economists is for a smaller 0.1 percent fall in GDP in the third quarter. But there is a real possibility that growth was actually stronger and could even have been flat on the quarter.

A 2 per cent increase in construction, an improvement in the business investment picture and a narrower trade deficit than was first reported suggest the economy improved between June and October this year.

If the UK exited recession in October, albeit on the third revision of the data, then this would set the stage for a stronger recovery in the last three months of this year and into 2010. Already we have seen a slowdown in the pace of unemployment for November, and the high street retailer John Lewis reported record weekly sales revenues last week of £112m.

Coupled with low interest rates for the foreseeable future, those with variable rate mortgages have more cash in their pockets compared with a year ago, which should boost consumer confidence. If it turns out that the economy is no longer contracting this will reverse the fortunes for sterling, which has spent most of 2009 as the weakest link in the Forex markets.

“I think Q3 GDP will get revised up as it was a bonkers number to start with,” says Robert Griffiths UK equity strategist at Cazenove, referring to the initial figure of -0.4 per cent. “All this year we’ve been on the positive side for sterling, and we think that the recovery will be stronger than people think.”

The UK economy still faces many headwinds and therefore investors should think about relative value when trading sterling. The euro, which gained an advantage over the pound when the Eurozone exited recession in the third quarter, could be on the back foot if the UK is revised out of recession today.

Sterling is also in a position to outperform the euro in the medium term, as the Eurozone recovery could be de-railed by the recent credit downgrade for embattled Greece. Spain and Ireland also face re-balancing their economies next year, which could weigh on growth.

But the outlook for sterling against the US dollar is less clear. “In the near term the US economic recovery seems to be more advanced [than the UK] and the Fed could tighten sooner than expected, giving the dollar some support,” says Howard Archer, chief UK and Europe economist for IHS Global Insight.

So should we be worried? Cazenove’s Robert Griffiths says that big political and macro economic risks need to be kept in proportion. “On a fiscal comparison the debt to GDP ratio is probably better in the UK than it is in the US and both countries’ economies are quite comparable. This means that if the credit ratings agencies downgrade the UK they should really downgrade the US.” This, of course, is highly unlikely to happen as it would lead to “financial Armageddon.”

Some have suggested that a hung parliament in the UK could spell trouble for the economic outlook, and even a downgrade for sterling. But such fears could be exaggerated. Griffiths says that the US is a “constitutionally” hung government due to the system of checks and balances which allows the executive and the dominant political party only limited powers. Since this does not warrant the US a credit downgrade, then he says that it should not for the UK, either. The future for sterling looks good. Good-ish, anyway.