Pound Sterling: UK Growth Revised Lower but Unlikely a Game Changer for the BoE

UK economy

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Thursday’s data will inevitably fill column inches but it is unlikely to prove a game changer for the Bank of England and Pound Sterling 

The Pound saw little respite from earlier losses Thursday when the Office for National Statistics revised its estimate of fourth quarter GDP growth lower, while separate data showed business investment stalling to a halt in the final months of the year.

Thursday’s figures showed UK economic growth was in fact 0.4% during the final quarter, not the 0.5% previously suggested by the ONS, dealing a blow to observers who had cheered a last minute lift in UK economic momentum during 2017.

The annual pace of growth was also downwardly revised, from 1.8% to 1.7%, with the revised number marking a fall from the 1.9% growth seen back in 2016. 

Thursday's downgradings were the result of recent revisions to industrial production figures and business investment having ground to a standstill. There was also a downward revision to services sector output but the ONS says didn’t impact on the headline GDP number.

"The downward revision from the first estimate was due to a small revision to production, which the ONS now thinks expanded by 0.5% on the quarter as opposed to 0.6%. That largely reflected a larger drag from the closure of the forties pipeline," says Andrew Wishart, a UK economist at Capital Economics.

"Mining output is now thought to have contracted by -4.7% on the quarter as opposed to -3.9% in the first estimate."

Business investment was unchanged in the final quarter while, for the year overall, investment grew by 2.2%. The annual number is down from the 1.9% seen in 2016.

Gross fixed capital formation, which is a broader measure of business investment, grew by 1.1% in the fourth quarter and by 3.9% for the year overall.

The Pound had already hit the ropes earlier in the Thursday morning session and was still marked down in the red after the ONS report’s release, with the steepest losses seen against a resurgent Japanese Yen and the Australian Dollar.

Sterling was quoted 0.14% lower at 1.3889 against the US Dollar and the Pound-to-Euro rate was marked 0.24% lower at 1.1299.

"Most forecasters expect GDP growth to slow further this year (the consensus is 1.5%). However, with inflation set to drop back – easing the squeeze on households’ real incomes – investment intentions remaining strong, and exporters still benefiting from a weaker pound, we expect annual GDP growth to strengthen to 2.0%," Wishart adds.

Thursday’s data comes closely on the heels of the fourth quarter labour market report, which showed the unemployment rate rising for the first time since July 2015, although the ONS attributed this to a rise in the participation rate rather than an increase in job losses.

While Thursday’s report will inevitably fill a great deal of column inches, it is unlikely to prove a game changer for the Bank of England and Pound Sterling in the months ahead, given that in November the Bank had forecast fourth quarter GDP of 0.4% and not 0.5%.

The Bank also forecast in its February inflation report (Page 34, table 5.B) that UK GDP will grow by 1.7% in the year to the end of March 2018, suggesting it expects Thursday's revised pace of growth to prevail in the first quarter of 2018.

In other words, the downward revision is in line the BoE's view of the economy and so may not deter the Monetary Policy Committee from the more hawkish path it set itself on in February's inflation report

The BoE warned in February that if the inflation outlook evolves in line with its latest set of forecasts over the coming months then it could raise interest rates at a faster pace than it had previously led markets to belief.

It already hiked the Bank rate by 25 basis points in November, to 0.5%, after inflation rose above the 3% threshold. Consumer price growth has remained at 3% ever since, when the Bank of England’s target is 2%.

Markets are now betting the BoE will raise rates at least once this year while pricing in interest rate derivatives markets, which enable investors to protect themselves against changes in interest rates, currently implies around a 50% probability of two rate rises from the BoE in 2018.

The central bank would raise interest rates in order to reduce inflation over a two-to-three year horizon. Higher rates would be expected to reduce inflation by sapping demand from the economy, although they would also boost the Pound, which would then further reduce inflation by making imported goods cheaper to buy.

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