UK economy shrinks as Cameron and Clegg continue with 'Plan A'

Week Commencing Monday 28th January 2013

Overriding Market Themes

The UK economy shrank by 0.3% in the last three months of 2012, fuelling further fears that the economy could re-enter recession. The Office of National Statistics said the fall in output was largely due to a drop in mining and quarrying, after maintenance delays at the largest oil field in the North Sea. Although obviously bad news for Britain, the economy had grown by 0.9% in the previous quarter (albeit helped by a certain sporting event held in the capital!), and when taking this into account, 2012 saw neither growth nor contraction. Diving further into the release, manufacturing fell by 1.5% in the quarter, the services sector was flat but construction output rose by 0.3%. If the economy were to also shrink in the first three months of 2013, then the UK would technically re-enter recession, the so-called ‘Triple Dip’. We however are more optimistic than most, and expect growth to continue to be fairly flat throughout the winter, but pick up momentum gradually throughout 2013, especially as the global economy picks up and confidence lifts. Let’s hope we are right!

Despite the dismal growth figure, it seems that the UK government is set to continue its plans for the biggest fiscal squeeze since the Second World War. The deputy Prime Minister, the ever so popular Nick Clegg, stated on the BBC that the government will not deviate from plan A, and continue to try and reduce one of the world’s largest budget deficits. This should reassure markets that the government continues to be committed to reducing the deficit, and with David Cameron’s speech on Europe out of the way, hopefully we can now see some support for Sterling. Interestingly, despite recent economic events, support for David Cameron’s Conservative party rose 5 points to 33% his European speech, while the opposition Labour party held at 39%. Nick Clegg should also be happy as support for the Liberal Democrats increased by 2 points to 11%t, while the U.K. Independence Party, which is campaigning for an exit from the EU, dropped 4 points to 10%.

The European Central Bank said banks will next week repay more of its emergency three-year loans than economists forecast in another sign the euro region’s debt crisis is fading. It is expected that some 278 financial institutions will return approximately 137.2 billion euro’s at the end of the month, the first opportunity for early repayment of the initial three year loans. After the news, the euro rose about half a cent both against the Pound and US Dollar, leaving it at the highest level for 13 months against Sterling. It demonstrates that the ECB’s LTRO program (Longer Term Refinancing Operations), which totalled more than 1 trillion euro a year ago, is helping to get banks’ lending to each other, and spurring the optimism it was originally intended to produce.

It seems the jobs market in the US probably kept making headway in January, even in the face of Washington’s fiscal cliff battles. Employers added 160,000 workers to the payroll last month, a astounding number considering December’s increase of 155,000. These sustained gains in hiring are giving incomes a real lift, and cushioning workers from the sting that the higher income tax level is causing. In even more good news for the Americans, manufacturing is showing signs of emerging from a lull that began in the middle of last year, with factory output expanding for a second month in a row. Nevertheless, although the world’s biggest economy is usurping its peers in the growth league tables, a still dangerously high unemployment level and on-going fiscal cliff negotiations mean that the country is not out of the woods yet.

GBP This Week

With very little UK economic data expected next week, all eyes should remain on the countries relationship with Europe and the government’s deficit reduction program. In fact, the only release of note is Manufacturing PMI on Friday, which we expect to come in at 51.0 against last month’s 51.4. This should tie in with the GDP reports statement on manufacturing, and continue to add pressure against the pound. However, with the recent decline Sterling has suffered, and in the absence of more potentially damaging economic data, we should see a reversal in its fortunes. Current prices offer traders a fantastic level to take profits on GBP shorts, whilst international demand for Sterling continues to rally in light of our AAA credit rating (however likely that is to remain). Expect Sterling to make some modest gains throughout the week, especially against the US Dollar. 

USD This Week

This should be a massive week for the Dollar, with at least 10 releases of note this week. We would concentrate on Wednesday’s Advance GDP figure, which should show the economy grew in the fourth quarter of 2012 by 1.3%, against a previous quarters posting of 3.1%. Although a drop is momentum, the fact that growth exists remains of significance. Also on Wednesday, the Federal Reserve is not expected to make any policy changes this time, especially after making a big move last time. The recent decision was dramatic: more open ended bond buying and a change in guidelines towards employment and inflation targets. While some members saw a potential easing in easing towards the end of the year, this does not reflect the dovish stance of most members, including Bernanke. If nothing surprising happens rates will probably remain low until 2015, and a reduction in QE is not expect until 2014. Finally, we would look at Friday’s ISM Manufacturing PMI figure, which flipped to expansion in December reaching 50.7 from 49.5 in November. This time around, we are expecting a further rise to 50.8.

EUR This Week

With no economic releases of note out from the Eurozone, all eyes continue to be sighted on analysing comments from the World Economic Forum in Davos, which finished on Sunday. I do not expect any huge market reaction to the political jostling that took place, but you may well see some movements on the slightly more exotic pairs involved in the discussions. Moving towards the end of the week, traders will be analysing the first repayment tranche of the LTRO, and should we see the levels I indicated above, expect the euro to rally slightly. All EUR movements this week should be politically motivated, so we will continue to monitor the news wires and release updates accordingly.

In Other News

Novak Djokovic has won his fourth Australian Open title as Andy Murray's hopes of a second major win ended. The Serbian tennis star was by far the stronger player, and outperformed the Scot for most of the latter part of the three and a half hour game. This means that Novak has six Grand Slam victories, and matches the likes of Boris Becker, Stefan Edberg, Don Budge and Jack Crawford in the all-time list, and being young, perhaps even more!


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