Little steps of growth should keep QE at bay

THE UK economy had a good day yesterday. GDP data came in at double what the market was expecting and the rating agency Standard & Poor’s said we no longer face the risk of a downgrade. The good news got instant reactions for sterling, gaining one per cent against the euro and a cent and half against the dollar. But is this enough to keep a further round of quantitative easing (QE) at bay?

Michael Hewson of CMC Markets thinks so: “QE is certainly less likely in the short-term. The BoE will be acting prematurely if they thinks that further QE can be born out of these growth figures – the figures are a knock for the doves.”

Pessimists however think that this quarter’s growth is overly dependent on a temporary spurt in the construction industry. Paul Robson of RBS does not think that the impressive GDP headline number will be enough to stop the Bank of England (BoE) opting for more QE: “I don’t think the construction industry can sustain the same rate of growth in the next quarter. The Bank will focus on things such as the service sector figures because it is the largest sector in the UK. So far those figures have been really weak.”

“The biggest signal for more QE is going to be the purchasing managers index (PMI) release ahead of the BoE meeting,” says Robson. He reckons only breaking the 53.0 threshold will hold the Bank off more intervention. RBS Economics are still calling for QE this November.

“Those calling for QE are doom merchants,” retorts Hewson. “Sure, fourth quarter predictions point downwards, but they do everywhere. We’re going to experience a few more years of sub-par growth while investors pay down their debts.”

But both Robson and Hewson agree that the Eurozone is in for a rough ride in the next quarter. Indeed, RBS European Economics expect a meaningful slowdown with a 40 per cent chance of renewed contraction. “I just don’t think that Germany can prop up the periphery for another quarter,” says Hewson. This could offer sterling a relative boost. Their target numbers however vary. Robson thinks sterling will stay closer to £0.90 than £0.88 to the euro, while Hewson thinks that would be overvalued.

On cable, analysts continue to draw comparisons between the UK and US situations. The fundamentals for both are so alike at moment that they often trade in tandem versus the rest of the market.

Sterling traders should look for further small steps towards stability and growth in the UK regardless of where they sit in the BoE debate. These steps will give the strongest hints on the likelihood of further QE. Should the Eurozone economy suffer and economic news from America continue to be bad, sterling could be in for a rally.