Sterling Crashes as UK Economy Contracts

Surprising even the most pessimistic forecasters, data has revealed that the British economy contracted by 0.5% in the three months through December 2010. It should be emphasised that this is only an initial estimate but nonetheless the pound went into a sharp decline in response. Foreign exchange (FX) specialist, Caxton FX, said the figure certainly comes as a shock, particularly after the market forecast was for a 0.5% expansion in the fourth quarter.

Arguments for an interest rate rise will now be receding coyly into the background with the economic recovery grinding to a halt. Unsurprisingly, the pound fell sharply across the board as the numbers were released, dropping in excess of a cent against the US dollar in a matter of minutes.

Duncan Higgins, currency market analyst at Caxton FX, said: “Measuring the economic impact of December’s weather conditions was always going to be tough, but the 0.5% contraction is clearly a staggeringly poor figure. As this is only estimated data we’re not expecting the Bank of England to fully reassess the strength of Britain’s economic recovery at this stage. However, this does mark a substantial step back and could force downward revisions to both 2011 and 2012 economic growth forecasts.

“The figure will almost certainly have slashed any expectation of an early interest rate rise. Indeed, the case being made by the dovish voting members of the Monetary Policy Committee has gained credence,” he added.

Certainly the data pushes back sterling’s forecast for a turnaround in trend against the euro. Market focus will now be squarely on the UK economy, particularly as the headlines have been noticeably light on eurozone developments recently. For the short term at least sterling will struggle, with investors unlikely to have the UK economy at the top of their list of countries to park their funds.

Higgins concluded: “Having already been on the back foot in the run up to the release, the pound has crashed in the wake of it. Sterling dropped a cent against the euro and two against the US dollar, with US$1.60 looking like a distant memory.”


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