Awful growth report sinks Sterling as risk assets, euro rally

Tom Tong28/Ιαν/2013Currency Updates

Investors continued their shift out of cash and riskless assets. equities, commodities and junk bonds rallied again last week, as the perception spreads among investors that tail risks have been removed from the world economy by aggressive central bank intervention.

Currencies reacted as one would expect in such an environment, with the conspicuous exception of sterling. A much worse than expected GDP report in the UK hit the currency hard. GBP dropped for the second week in a row against almost every major currency; a very rare bout of under performance.

Another redevelopment is the collapse of the risk-on, risk-off correlations across currency pairs, as FX moves are increasingly driven by local developments. Euro rallied as investors focused more on the easing of financial conditions in the eurozone than on the dismal macroeconomic news.

It seems clear that investors are choosing to ignore for now the latter, and are focusing on the former; therefore, we will be revising our short-term forecast for EUR/USD higher early this week. Stay tuned.


The big news out of the UK was the GDP report for the last quarter of 2012. This came out significantly lower than the consensus expected, printing a 0.3% QoQ contraction that works out to -1.3% in annualized terms.

The weakness was widespread, and fails to resolve the contradiction between dismal growth data and the more resilient labour market. Sterling took it badly, falling 1% against the dollar and 1.5% against the euro. The release of the minutes from the MPC meeting earlier in the month were somewhat more hawkish than expected, but this did not help sterling much.

We expect the latest data will start changing minds at the Bank of England. While we do not expect the February meeting to result in expanded QE, the minutes from the meeting should have a distinctly dovish tilt.


There was some improvement in the here-to-fore dismal news flow out of the European economy last week. The PMI business sentiment index improved 1 point to 48.2, to a level still consistent with mild economic contraction.

However, the sharp divergence between Germany and the rest of the major economies has returned. While the German number rose to over 53, it declined 1.9 to a dismal 42.7 in France. The periphery continues to sink, with the PMI index firmly into contraction territory at 46, and Spanish data failing to show any improvement either in employment or growth.

Investors, however, focused on the German data and the early repayment of 137 billion euros of the first LTRO operation by European banks, about 25% of the total borrowed, and sent the euro higher beyond the 1.34 level against the dollar.


Very little market-moving news out of the US last week. New and existing home sales dropped somewhat from the previous month, but this comes after several very good months and does not change our view that the US housing market is experiencing a healthy, sustainable rebound. Weekly jobless claims fell to the lowest level since the expansion began, as did the four-week moving average.

While most strategists are focusing on the fiscal drag on consumer spending from the tax increases in effect for 2013, we expect that expanding labour incomes will make up for this and see consumer spending growing near 2% in real terms, and the overall economy somewhere in the 2-3% range. We think that Federal Reserve communications will soon become more optimistic as a result, and the resulting back up in interest rates will provide solid support to the dollar during 2013.


Written by Tom Tong

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