A pound-euro rally is possible, despite GDP

BRITAIN&rsquo;S inability to emerge from recession in the third quarter was both a shock and a bitter disappointment. Traders had been widely expecting the economy to grow in the three months to September, albeit at an extremely slow pace. As a result of the unexpected contraction, sterling dropped more than a cent against the greenback and also fell against the euro.<br /><br />But today we will find out whether the 0.4 per cent contraction will be revised, as most initial GDP figures are. City analysts are expecting that the contraction will be rounded down to -0.3 per cent, although there are considerable risks to this estimate on either side. Very few economists correctly predicted that the UK would remain in recession in the third quarter.<br /><br />But what will the revision mean for sterling this time around? If the data comes in as expected, then this should see further stabilisation in sterling against the US dollar. If the data is higher than expected, this will see the pound strengthen even further against both the euro and the US dollar &ndash; figures released yesterday revealed that the world&rsquo;s largest economy grew at a weaker pace in the third quarter than previously predicted. <br /><br />Despite the poor performance of the UK economy, there are signs that things are improving. Duncan Higgins at Caxton FX says that he has &ldquo;an encouraging view over the medium term&rdquo;. He points to data out this month that revealed an improvement above expected levels in both the manufacturing and services sector, which has made market analysts optimistic about the UK&rsquo;s growth prospects for the last quarter of this year.<br /><br />But Higgins thinks that, despite this good news, any advances in sterling will be slow to come. &ldquo;The pound is facing strong headwinds from its spiralling fiscal deficit and lingering concerns over quantitative easing. With no confirmation from the Bank of England that stimulus measures have come to an end, the market is hesitant about taking the pound too high,&rdquo; he adds. Yesterday, sterling dropped sharply following comments by Bank of England governor Mervyn King, who gave little indication as to the future of UK monetary policy when he spoke in front of the Treasury Select Committee. <br /><br />Sterling has consolidated its gains against the dollar because of the greenback&rsquo;s weakness, and not any intrinsic strength. Even as it has gained against the dollar, it has made little headway against the euro. <br /><br />However, with sterling trading at such oversold levels against the single currency, a rally in sterling-euro over the coming months cannot be discounted, whatever today&rsquo;s GDP figure shows.