Sterling trend may continue to be a friend

IT HAS been difficult to accurately gauge the performance of the UK economy recently. The Olympics, Diamond Jubilee, and even the weather, have distorted the picture.

In the last month, we have had positive government borrowing figures, excellent retail data, equally impressive employment data and have seen inflation fall to three year lows. However, construction, industrial and export data have been far from positive.

This mixed data presents a dangerous problem for currency traders, increasing the risk of being caught on the wrong side of a price move.

Traders could stumble on such a landmine tomorrow, when the latest GDP reading is released. Analysts forecast 0.6 per cent quarter-on-quarter growth, following a 0.4 per cent decline in the second quarter. This would be good news for the UK economy, but can the data be relied upon?

Recently, GDP data for the second quarter was revised: from an initial estimate of a 0.7 per cent decline, the figure was revised upwards by 0.3 per cent. This is not an aberration. We had a similar situation in the second and third quarters in 2009 – initial GDP readings were markedly different to the revised numbers. Of course, this problem is not just something we have seen since the crisis began: in the 1980s and 1990s traders had to grapple with the same problem.

Chris Williamson of Markit thinks that GDP has never been a reliable indicator: “If you still look at GDP data, you have learned nothing from the past. Countless mistakes have been made from taking first readings of GDP as gospel.”

Williamson thinks that traders should focus on the purchasing manager’s index data, which is compiled by his company. The data has proved to be a far more reliable indicator than GDP in recent times. “Look at the PMI data, that is what the Bank of England is doing; it hasn’t been using GDP data for the last 18 months.” He also points out that towards the end of 2009, PMI data showed that the UK was out of recession, contrary to official GDP estimates.

Christopher Beauchamp of IG has a dim view of GDP as an indicator: “GDP should be taken with a pinch of salt. I wonder why they bother with the first estimate.”

Although the domestic market is showing signs of life, weak global growth is dragging on the UK’s economy. As a trade-dependent, export focused economy, this has affected exports, which in turn has dragged on demand for sterling.

Beauchamp expects continued sterling weakness. “There may be room for sterling to move up, if annual data is much better than expected,” but given that traders are focused on the Eurozone situation and the US election, he does not believe there will be much of a reaction. “Flat data will certainly not surprise the market.”

If GDP surprises to the upside, Beauchamp thinks that we will need to see confirmation by other economic indicators – such as retail and PMI data – in the medium term, before sterling-dollar moves towards the $1.62 level.

GDP disappointment will force a stronger reaction from sterling. David White of Spreadex thinks “a poor reading could see sterling fall to $1.59, but all of the bad news seems to have been priced-in already”.

Sterling-dollar is in a curious place. Both the UK and US economies have debased their currencies through quantitative easing and White thinks that “it is a war of attrition between the two, and both look ugly”.

The pair has been on a downtrend since mid-September, White advises traders to ride the trend. “Sometimes the best thing is not to make a call, and understand that things may stay where they are.” He cautions traders about being overly gung-ho: “You need to be taking risk for a reason, if you can’t find a compelling reason, stay put and see what happens.”