This is a special series of articles, we’ll be taking a detailed view on various British Pound pairs, consider the past moves as well as try and forecast future prices. To start off, in this first installment, we’ll summarize the fundamentals to gain a better understanding on the UK’s economy and monetary policy which will set the tone for the British Pound’s direction for the year 2014.
A well steered monetary policy by the Bank of England, harsh austerity measures from Chancellor Osborne, combined with an overall improvement in economic activity saw the stellar rise of the UK from a worrisome double dip recession. Indeed, the Pound Sterling was the sole performer among the world’s economically developed countries.
Despite starting the year on a high at 1.634, the British pound slumped during the first half of the year, bottoming at 1.4812 but not before closing the year at the highs of 1.648, approximately 11% increase or close to 1670 Pips. During the course of the year, the economic forecasts were mixed and at one point the coveted Triple A investment grade status was also in jeopardy. Yet, despite the headwinds, the Pound Sterling managed to rise steadily, outperforming most of its peers.
From the fundamental point of view, here’s a brief recap of the UK’s key economic indicators to date.
Purchase Manager’s Index – UK
The Purchase manager’s index is considered to be a good indicator of the underlying economic activity of the country. Overall, PMI across all three sectors have steadily increased during the year 2013 reflecting the growth in the UK’s economy. Following three sectors, the charts depict the PMI index respectively.
Tracking the activity in the construction sector, the UK’s construction PMI has been on an uptrend since the start of 2013, printing a 48.7 reading on the index for Jan 2013. This level of contraction reflects the UK’s recession during the previous year. Construction PMI changed for the better after hitting a low of 46.8 in Feb 2013 after which activity picked up steadily. November’s construction PMI reached its highest levels of 62.6.
The services sector noticed a pick up in activity at a steady pace. After rising to the highest levels of 62.5 in October 2013, the services PMI dropped to 60 during November 2013. Despite the drop, the services index continues to post an expansion. Analysts believe that the drop in the services PMI was well within acceptable levels given the 2.5 point rise between September and October.
The manufacturing PMI, during the year 2013 saw a stellar rise as can be clearly seen from the chart below. Manufacturing peaked in August 2013 to 57.1 but dropped 56.3 low during September, followed by another increase to 58.4 in November. If one is to believe the correction in September and October data, it is quite possible for manufacturing to continue to rise well into 2014.
UK GDP Growth
The country’s GDP growth picked up as well during the year after the first quarter of 2013 saw a negative GDP contraction to -0.1%. The Q2 and Q3 saw a pick up in growth yo 0.5% and 0.8% respectively. The chart below depicts the GDP growth since 2008. Notice that the GDP growth is still below the peak of 1% growth noticed in 2010.
The IMF’s world economic outlook forecasts the UK’s GDP for 2014 to increase by 2.2% on a yearly basis while it puts the Quarterly (Q4) GDP forecast to improve to 2.3% in 2013.
Unemployment, Inflation & Housing
The unemployment rate for the UK was probably one of the most talked about economic indicator as it ties in closely with the BoE’s monetary policy. Current unemployment rate for the UK stands as multi-year low of 7.4% but still far from the BoE’s target of 7%. The pick up in the services, construction and manufacturing attributes to the improvement in the UK’s unemployment rate.
Compared to the US’s the UK’s jobless rate was lagging but current statistics show that the UK’s unemployment rate is fast catching up with that of the US, as depicted in the comparative chart below.
In regards to the inflation rate, the BoE had set its target of 2%. Latest data showed the UK’s inflation rate falling to 2.1% during the periods of Nov/Dec 2013. However, inflation is expected to pick up again on account of the Sterling strength as well as the energy and gas price hike across the UK.
While the signs are clear that the UK’s economy is definitely moving out of recession, there are still visible weaknesses in the growth which could trigger a period of depression where output is likely to fall below its peak.
Perhaps one of the biggest threats to the growth of the UK’s economy could likely come from the housing market. In just a few months, the housing markets moved from near stagnation to reaching record highs. Halifax reports that the housing prices are likely to rise at 6.9% annually while Nationwide forecasts a rise of 5.8%. The projections sparks fears of a possible bubble in the UK’s housing markets. This was further validated by the BoE’s recent decision to shift focus of its FLS scheme from home buyers to the SME sector. But with an improved work force, it is quite likely that the housing markets will continue to see a steady demand as the central bank keeps its interest rates low.
BoE’s monetary policy
By initiating a series of measures to improve the economic activity of the country, the UK’s Central Bank implemented various policies such as keeping the key benchmark interest rates at history lows of 0.5% while engaging its own QE program injecting £375 billion into the economy. Apart from the above two, the Central bank also engaged in some direct policies such as the Funding for Lending scheme aimed at improving the housing market in the UK (which seemed to have worked considering that the BoE announced an end to the FLS scheme for home buyers and shifting focus to the SME sector in 2014). The year also saw a change of guard with Mark Carney taking over as the BoE’s Governor from the incumbent Sir Mervyn King.
From a fiscal policy point of view, Britain embarked on a harsh series of austerity measures in an attempt to reign in the current account deficit along with measures to reducing the government spending by £11.5bn with cuts spanning across welfare, government departments through 2015 -16. The results of which are still to be known.
Overall, the UK’s economy has definitely turned the bend for the better but what remains to be seen if whether the current growth rate will be sustainable over a period of time. For the moment, it looks like the country is definitely set to continue on in its upward growth trend. If the Eurozone’s economic growth shows signs of picking up, it is quite likely that UK’s growth will definitely get a shot in the arm.