UK growth augurs well for this year and next

The UK economy has experienced a marked improvement in 2013, with growth picking up in the first half of the year, after it stagnated last year.

The preliminary estimate of GDP growth in the second quarter showed that the economy registered quarterly growth of 0.6%.

This followed a 0.3% increase in the first quarter and is the first time since 2011 that the economy registered two consecutive quarters of growth.

In terms of more timely macro updates, leadingindicators, such as the PMIs, are pointing to a strengthening of the economic recovery in the second half of the year. The services PMI for July reached its highest level since late 2006, while the July manufacturing PMI was at it’s best level since early 2011.

There are also encouraging signs emanating from the consumer side of the economy. The latest retail sales figures for July came in ahead of market expectations and represented the third consecutive month that sales recorded positive monthly growth.

Notwithstanding the one- off boost to spending in July from the unusually good weather, the latest sales data suggest the third quarter got off to a solid start in terms of consumer spending.

The pick up in activity appears to be having a positive impact on the labour market.

The most recent employment data, which cover the three-month period up to June, showed an increase in jobs of 69,000 over this period, with the majority of these gains coming from full-time job creation.

In terms of the economic outlook, although the UK economy still faces considerable headwinds (including household deleveraging, fiscal tightening, still high unemployment and weak real income growth), the recent trends suggest the economy could grow by more than 1% this year and by close to 2% in 2014.

On the monetary policy front, new Bank of England governor Mark Carney, has overseen the introduction of forward guidance by the bank. UK interest rates have been at the historically low level of 0.5% since March 2009.

BoE has indicated under its forward guidance that it plans to keep them at their current level and not to start unwinding its asset purchase programme until the unemployment rate falls to at least 7%, something its does not expect to happen until around mid-2016.

From a currency perspective, sterling lost 6.5% on a trade-weighted basis in the opening two months of 2013, as markets worried that the economy’s sluggish performance at the time would trigger further quantitative easing by the Bank of England.

The currency fell below $1.50 against the dollar, having previously being confined to a narrow $1.55- 1.65 range since mid 2010. Sterling also fell from 81p to 87.5p against the euro.

However, since then, the improvement in the economy, combined with monetary policy being kept on hold, has seen sterling largely trade in a $1.50-1.56 band versus the dollar and at 84-88p against the euro in the past six months.

A key event risk for the currency in recent months has been the change of leadership at the Bank of England and the introduction of forward guidance. However, sterling appears to have largely absorbed the news at this stage.

The introduction of forward guidance had been well flagged and the actual details of the guidance proved to be less dovish than the market had been anticipating.

Overall, given the pick up in the economy, we expect sterling to remain range bound against the euro, probably in the 84-89p range — there is good technical support for sterling at the 88-90p level.

Cable (i.e. sterling/ dollar) could ease back below the $1.50 level again, though, if the US economy strengthens and the bond-buying programme there is wound down, boosting the dollar. Finally, any re-emergence of talk about the UK leaving the EU would pose a downside risk for sterling.

* John Fahey is a senior economist with AIB