The most important data release for cable this week will be the UK monthly GDP data, released on Friday. As global economies face pressure from inflation and central banks turn more hawkish, the variance in economic performance is becoming a bigger factor in determining currency performance. GDP growth determines how much the central bank can hike and whether higher prices will lead to demand destruction and weaken the currency.
The pound has outperformed the Euro amid general dollar strength lately. This comes after sterling suffered amid a political crisis that hasn’t entirely gone away but has been put on the back burner, at least as far as the markets are concerned. Investors seem to be betting that the UK will grow faster (or at least avoid a recession) than the Eurozone. This could support capital flows into the UK, further bolstering the pound. But that depends on the economy continuing to eke out gains.
What the Market is Looking For
Britain’s economy is expected to have slowed slightly in April, but to remain positive at 0.1% compared to 0.3% in March. This would allow the rolling three-month average to accelerate to 0.8% from 0.6%. Over the last several months, UK economic data have surprised forecasts, growing faster than anticipated, thanks to resilience in the services sector. In the current energy situation, the UK has an advantage over the Eurozone because of its substantial domestic oil production. Britain still has to import energy, but it’s a much smaller share than the Eurozone’s.
The war in the Middle East is still expected to take a toll on the economy, so signs of resilience will be positive for the pound, even if it declines compared to the month before. A solid print would support the BOE’s ability to raise rates and keep inflation in check, and is an important factor for restoring confidence in Britain’s fiscal stability.
The Pound’s Gilt Problem
Britain has seen one of the fastest rises in long-term sovereign yields worldwide, let alone among developed nations. Investors are worried that the government won’t be able to collect enough taxes to meet its financial obligations and will have to take measures that will weaken the currency. As a result, they are demanding higher premiums on UK government debt, thereby exacerbating the problem, as the government is forced to pay higher interest rates on its debt.
The biggest fear is the potential for higher inflation driven by increased deficit spending to compensate for a lack of revenue. If the country has high inflation and the BOE is unable to stop currency debasement due to a stagnant economy, it creates a toxic situation. As a result, GDP growth is the pressure release for the pound, as it means the government secures more revenue without changing its fiscal rules, and the BOE has more room to act.
How the Market Could React
The market expects the BOE to stay on hold at the next meeting, but the odds of a rate hike increase if there is a substantial beat in the GDP number. Unlike with the Euro, this could support the pound, as UK assets become more attractive.
If the UK GDP number turns negative, the pound could weaken against the Euro and the dollar. Investors would be worried that Britain is about to follow the Eurozone into a technical recession and move assets across the Atlantic.
