British GDP Contraction in Q4 Worst Since 1975

Daily Forex Fundamentals | Written by Wachovia Corporation | Jan 23 09 15:15 GMT |

Real GDP data confirm what essentially every investor already knew: the British economy is in a deeper recession. And it probably will continue for the next few quarters. Concerns about the state of the British banking system and the weaker-than-expected GDP data have caused sterling to drop to a 24-year low against the dollar. British Economy in Deep Recession Data released this morning confirmed what essentially every investor already knew: the British economy is in a deep recession. As show in the top graph, real GDP contracted at an annualized rate of 5.8 percent in the fourth quarter relative to the previous quarter, the sharpest contraction since the second quarter of 1975. A breakdown of the real GDP data into its underlying demand components will not be available until next month, so we can only surmise the sources of the obvious economic weakness. With the ongoing collapse in the housing market, it seems certain that residential construction (or lack thereof) helped to pull down real GDP again. Overall investment spending plunged at an annualized rate of 11 percent in the third quarter and, given the freeze up in credit markets lately, another sharp decline in the fourth quarter likely occurred. Curiously, monthly data indicate that the volume of retail sales rose 2 percent in the fourth quarter. Either the monthly data are flawed or an unprecedented plunge in inventories occurred in the fourth quarter. In any event, it is questionable how long consumer spending can remain supported with the labor market deteriorating quickly (see middle chart). Looking forward, we project that the British economy will continue to contract over the next few quarters. On a peak-to-trough basis, we believe that real GDP will decline about three percent, worse than the 2.5 percent contraction that occurred in the early 1990-91. Could the current downturn match the six percent plunge in real GDP that transpired between 1979 and 1981? Probably not, but with the British banking system in turmoil at present our forecast may not be downbeat enough. Sterling Plunges to 24-Year Low Sterling has fallen significantly against the U.S. dollar since last summer when investors began to anticipate the onset of the current British recession (see bottom chart). It dropped even lower this week - falling to a 24-year low - due to concerns about the viability of the British banking system and the weaker-than-expected GDP data. The pound has dropped a significant amount in a relatively short period of time, so some retracement is inevitable sooner or later. That said, it is hard to envision a sustained appreciation in sterling as long as there is no end in sight to the troubles in the U.K. economy. Indeed, we believe that the Bank of England will cut its policy rate, which currently stands at 1.50 percent, by at least another 100 bps over the next few months. Therefore, sterling will probably continue to trend lower against the dollar over the next few quarters, although probably not at the same rate as it has since last summer. Wachovia Corporation http://www.wachovia.com Disclaimer: The information and opinions herein are for general information use only. Wachovia Corporation and its affiliates, including Wachovia Bank, N.A., do not guarantee their accuracy or completeness, nor does Wachovia Corporation or any of its affiliates, including Wachovia Bank, N.A., assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, are for general information only and are not intended as an offer or solicitation with respect to the purchase or sales of any security or any foreign exchange transaction, or as personalized investment advice. Securities and foreign exchange transactions are not FDIC-insured, are not bank-guaranteed, and may lose value.