UK GDP NUMBERS SHOCK INVESTORS

GDP in the UK decreased by 0.7 per cent in the second quarter on weakness across all sectors. It seems that the dreaded double dip couldn’t be avoided and the string of negative GDP prints has now been extended to three quarters.

The UK Office of National Statistics released the second quarter GDP numbers earlier in this morning and shocked everyone with the -0.7% headline figure. City analysts and economists across the globe were pointing to a decrease of just 0.2%, but the contraction was much more pronounced due to weakness across all component sectors and in particularly construction.

GDP numbers

After recovering slightly in the third quarter of last year, the British economy was not able to keep the train on the rails, even though the services sector has recovered well from the financial crisis. Production and construction are sluggish and still lagging behind. A particular cause for concern is the construction sector and which was one of the most affected in 2009, decreasing 13.5% in that year. In the following years of 2010 and 2011, it was able to recover 7.9% and 2.8% respectively, but weakness is apparent once again as reflected in the above table. The sector is down 5.2% in the second quarter and that just adds to the 4.9% loss in the prior period.

GDP attribution table

If we look at the contributions to growth for the output components of GDP, we see that the construction sector has contributed with -0.4% of the -0.7% change in GDP for the second quarter. Similarly this sector was responsible for effectively all the decline in GDP in Q1 too – something is broken in the system in the UK with such a need for housing yet the sector not able to actually meet this very real demand.

Manufacturing and transport, storage and communication have been also weak while government and utilities continue to give a precious help.

Market Reaction

The FTSE actually traded higher after the report was published as the market continues to expect further easing and so additional flushing of liquidity into financial assets. The pound was however hit down. Cable was trading at 1.5550 before the GDP numbers were released but was driven down to 1.5470 in the following half hour, losing 80 pips.

What to Expect in the Future?

With the Olympics just getting underway, the British economy will probably get a much needed boost in the third quarter and so likely avoid extending the dip for a whole year. The Bank of England may be tempted to extend monetary easing but looking at the current situation the effects from it are questionable. Conventional measures of monetary policy have been exhausted. The key interest rate is now held at 0.5% and any cut will only help on creating inflation and enlarging the profit margin of banks and won’t translate into easier and cheaper access to borrowing.

The UK has an unhealthy construction sector that needs a boost from Government, not the BOE. People aren’t buying new homes on faltering credit conditions and depressed expectations about the future. With too many austerity measures being implemented by the government and decreased prospects of finding or keeping a job, it is no surprise the construction sector is finding it difficult to sell anything. The job market needs a boost before the construction sector has a chance to pick up and the UK government has a cracking chance to do that since the yields on 10-year Gilts are the lowest ever – somehow we doubt Mr Osborne will extend the public debt though to fund this sector!

How to use GDP Numbers to Spreadbet the Markets?

Shorting the pound expecting for additional monetary easing may not be the way to go. Unless you find the right pair or cross, sticking with EUR/GBP or GBP/USD may not give you the desired effects. Although any increase in the likelihood of monetary easing will lead to pound weakness, just remember that the likelihood of monetary easing in the US and the EU is also high. The weakness experienced in the UK has been also experienced in the EU and the US and the pound has been a winner against the Euro and a loser against the USD out of this game.

The correlation between the USD and S&P 500 is also high, meaning that a bullish market will drive the USD down, including against the pound. That is happening today. Even though cable lost ground right after the GDP report, most of the loss was recovered as the S&P is edging higher. If you want to explore pound weakness, then you have to find a cross with an economy in a better shape. A good candidate would be GBP/AUD. The latest economic data coming from Australia has been improving and the RBA has stopped wthe recent monetary easing. The pair has been on a huge downtrend since the beginning of May.

GBPAUD chart

In terms of equities, it may be worth looking inside FTSE 350 sectors indices. Financial & business services, and utilities seem to be recovering well from the crisis. Some service-related sectors can also benefit from the Olympics. Looking inside these sectors may be a better bet than just backing the whole FTSE market. Construction, household materials, and mining are examples of sectors that may have difficult times ahead.

Filipe R Costa