Pound Sterling Softer after July GDP Disappoints

• GBP softer at start of new week
• As UK GDP data disappoints
• EUR supported by Ukraine war developments
• USD still long-term winner

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The British Pound was soft at the start of a new week following the release of domestic GDP data that showed July's economic rebound was softer than expected.

UK GDP rose 0.2% in July, less than the 0.3% figure the market was expecting, nevertheless, this was still a sizeable bounce-back from June's -0.6% reading which was largely as a result of the extra bank holiday to mark the Queen's Platinum Jubilee.

The ONS said the UK's economic rebound in July was largely driven by growth in the services sector, but the bigger picture was one of stagnant economic activity with growth being flat on a rolling three-month time line.

The Pound showed some initial volatility in the wake of the data release but as the day progresses it is clear global drivers are in charge, with the Euro proving an outperformer at the start of the new week, ensuring the Pound to Euro exchange is down half a percent on the day at 1.1482.

"The euro has jumped to a more than 3-week high versus the US dollar this Monday and GBP/EUR is loitering around multi-month lows following the ECB’s hawkish meeting last week, pointing towards further aggressive monetary tightening. ECB policymakers could raise their key interest rate to 2% or more to curb record inflation in the Eurozone," says George Vessey, analyst at Western Union Business Solutions.

This means GBP/EUR rates quoted on typical bank accounts for euro payments are in the region of 1.1240, but at independent payment providers they are at around 1.1440.

The Pound to Dollar exchange rate is however half a percent higher amidst a broader setback in the Greenback: GBP/USD spot is at 1.17, quotes on bank accounts are in the region of 1.1460 and at specialists the rate is closer to 1.1660, according to our data.

Looking at the details of the UK GDP data shows, outside of services, activity was weak: industrial production (-0.3%) and construction output (-0.8%) disappointed, while manufacturing output (0.1%) recorded an expansion in July.

Above: "Services was the main contributor to the positive GDP growth in July 2022" - ONS.

The outlook for the UK economy remains challenging given ongoing elevated inflation and it could well fall into recession by year-end.

However, the introduction last week of the energy bill price cap by new Prime Minister Liz Truss is expected to radically cut the expected peak in inflation, thereby improving the outlook.

Some economists have even suggested the move means the economy won't fall into recession.

This would be a positive development for Pound Sterling and hints at a better end to the year.

Monday 19 September has been declared a public holiday as the nation lays to rest Queen Elizabeth; from an economic perspective this lowers September's GDP output potential.

"From the perspective of the economy there has been some talk that the resulting drop in economic activity in September will result in a contraction in Q3 as a whole. Since GDP suffered a minor contraction in Q2, this would imply that the economy is in a recession, albeit largely influenced by additional public holidays," says Philip Shaw, Chief Economist at Investec.

"While this is not our baseline case, we would not rule this out, especially if the subdued mood of the nation results in a dip in spending across the period of mourning," he adds.

The Euro meanwhile starts the new week better supported, "boosted by Ukraine news," says Frances Cheung, Rates Strategist at OCBC Bank. "EUR continued to inch higher, riding on Ukraine news, easing natural gas prices (fell 6% on Fri and down nearly 14% MTD) and hawkish remarks from Bundesbank’s Chief Nagel."

Joachim Nagel said on the weekend the ECB will be required to continue raising rates if current trend in CPI continues. The ECB hiked interest rates by an unprecedented 75 basis points last week, a move analysts say is required to cool inflation and prevent material losses in Euro exchange rates.

Ukrainian forces have meanwhile made significant gains in a counter offensive against Russian forces in the northern Kharkiv region, suggesting a potential tipping point in the conflict.

"It may be too early to call an end to war but if Ukraine forces can consolidate its regained territories and continue to pressure Russians, then optimism can grow and this can lend further boost to EUR," says Cheung.

Gas prices are meanwhile the ultimate concern for the Eurozone and its single currency and this week we will look out for further signs that the peak in gas prices has passed.

"Beyond the ECB there is also much focus on what more European politicians can do to address the energy crisis. Will GBP/EUR slide further south of €1.15 or will the 200-week moving average, which is proving a tough nut to crack, continue to support?" asks Vessey.

The Dollar's trend of appreciation remains intact on a longer-term basis and any setbacks in the Greenback are therefore widely viewed as temporary.

As such, further declines in GBP/USD and EUR/USD cannot be discounted.

That said, Tuesday's inflation data release will prove a key event for foreign exchange markets this week as any weaker-than-expected reading could deal the Dollar a setback.

"We agree that it may be too soon to declare victory on the fight against inflation but it is worth keeping a look-out on how slowing US data may influence Fed signalling in coming months and potentially, that can translate into USD easing," says Cheung.