April 08

U.K. Economy Takes a Breather

Sterling has seen an impressive rally over the past 6 months with GBPUSD rising from 1.48 to 1.68.  This increase has been driven by an astounding turn around in sentiment on the UK economy. In early 2013 economists and market participants served up gloomy predictions for the United Kingdom. The British economy was seen as weighed down by high public debt, outsized trade deficits and knock on effects from the 2012 Eurozone recession. Mark Carney was prepared to takeover as Governor of the Bank of England with a dovish stance and FX markets pushed GBPUSD sharply lower in early 2013. Shorts piled into GBPUSD taking it down from 1.61 in December 2012 to 1.48 by March 2013.

The massive turn in the performance of the UK seems to have been sparked by several factors. The government’s Help to Buy program along with it’s Funding for Lending Scheme stoked supply and demand for credit. Help to Buy assisted first time home buyers with making down payments, and allowed for higher loan to value ratios. Funding for Lending offered banks low cost funding for any net increase in loans to mortgage borrowers and businesses. These two macro prudential measures, along with lower interest rates stoked by the Fed and Bank of Japans easing programs have created a property boom in some parts of the UK.

You can see in the tables below, the turnaround in UK sentiment indicators. Construction PMI especially saw a significant improvement in a very short period of time. These drastic improvements have increased pressure on the Bank of England to hike interest rates early in 2015. Sterling’s rally over the past few quarters has been driven by this pricing in of interest rate hikes.

Things have looked great for the UK until recent PMIs, inflation and lending numbers have pointed towards an economy that may be cooling off. Last week all three main sentiment indicators missed expectations. Construction, services and manufacturing data all came in below estimates. Manufacturing was especially weak as growth expanded at the slowest rate since June of 2013. Falling inflation is also a significant threat to Sterling bulls that have seen inflation decline from 2.7% in September to just 1.7% in March. Inflation is now below the Bank of England’s 2% target, taking off a significant amount of pressure to hike interest rates.

Since the start of 2014 the Bank of England no longer offers banks cheap funding to make mortgage loans (funding for lending scheme). It seems this loss of cheap funding is now starting to make waves in the lending markets as approvals for new mortgages have fallen for the first time in several months. See the chart below:
Source: Bank of England

Translating this into a trading strategy, GBPUSD looks a bit hesitant to continue to push higher through a huge level of resistance between 1.68 and 1.70. If employment and retail spending data begin to confirm that the UK growth spurt is leveling off, Sterling may be in for a move lower toward as rate hike exuberance is scaled back.