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RECOVERY IS GAINING IN MOMENTUM

<strong>JANE FOLEY<br />RESEARCH DIRECTOR, FOREX.COM<br /><br /></strong>THE suggestion that the UK economy may return to growth by the end of the year is not new, but the recent spate of better than expected economic data appear to give legs to this possibility. Purchasing managers&rsquo; indices (PMIs) for July are suggesting expansion in both the manufacturing and services sectors during July, while the housing market appears to be stabilising and consumer confidence data is ticking higher.&nbsp; <br /><br />But that is not to say the economy is out of the woods. Revised UK GDP data for the first quarter and preliminary numbers for the second have both surprised on the downside in recent weeks.&nbsp; While the recession probably hit the bottom during the second quarter, the depth of the downturn proved to be far greater than previously assumed. <br /><br />Economic conditions may have turned around in time for growth to return by year-end, but the climb back to trend growth could be long and difficult. Unemployment, as a lagging economic indicator, could continue to increase well into next year. This will remain a hindrance to consumption as will the fall in average earnings, expectations of higher taxation (brought about by the sharp deterioration in the government&rsquo;s fiscal position) and falling pension provisions available to an increasing numbers of workers.&nbsp;&nbsp; <br /><br /><strong>CAUTIOUS OUTLOOK<br /></strong>Faced with all the evidence available to date it would be prudent to retain a cautious outlook with respect to economic recovery. This appears to be the view of the Bank of England (BoE) which expanded its quantitative easing program last week by a surprisingly large &pound;50bn. <br /><br />But following a three-month rally in stock markets from March, talk of green shoots became little more than hot air in early July as economic data surprised to the downside. More recently, stocks, oil and other commodity prices have found support on rising optimism that the global economic downturn could be drawing to a close. However, the doubling in oil prices since their February trough will, if the pace is maintained, eventually threaten to offset global recovery. This supports the view that recent rallies in stocks and commodities are in danger of overstating the degree to which demand has picked up.&nbsp; <br /><br /><strong>RELATIVE STRENGTH<br /></strong>While a cautious view on the recovery story is advised, the improvement reflected by UK economic data is better than that registered in both the Eurozone and in Japan; both of which are disadvantaged by the relative strength of their respective currencies. Despite the improvement in the UK economy, sterling remains 26 per cent lower versus the euro relative to its levels ahead of the Northern Rock crisis in September 2007. And it is over 30 per cent lower against the yen compared with September 2007. <br /><br />The Bank of England&rsquo;s quantitative easing program and the shockingly bad fiscal position of the government is currently undermining sterling. However, the aggressive action by the BoE supports the view that growth may return by year-end. Growth will simultaneously soften the fiscal position and support a reversal in BoE policy. So on a three to six month view, sterling may continue to trend higher versus the euro and the Japanese yen.&nbsp;&nbsp; <br />ResearchEmea@forex.com<br />