GBP strengthens - UK economy grows

The UK had an interesting 2022. There was plenty of hyperbole about fiscal black holes, the Bank of England restarting QE (it didn’t) when pension funds were getting smashed, and Trussonomics wasn’t around long enough to figure out if it was actually a good plan at the wrong time. GBP fell off a cliff and then clawed a lot back.

Especially against the previously rampant dollar. Now though, it’s hanging around at the 50 to 61.8% retracement zones. Some of the recent momentum has been lost and it’s harder to make the fundamental case for further GBP upside.

Nonetheless, the UK economy has been more resilient than feared, and the prophets of doom have once more seen their armageddon predictions defeated. Just because they were wrong though, that doesn’t mean the UK is on the verge of a boom.

Take a look at the wage growth across nations. While US wages have almost kept pace with inflation, the EU & UK haven’t:

Negative real wages is the official term. Everyday people say inflation reduces purchasing power. The effect is the same. But we still love a drink when the footy’s on (which somehow counts as ‘productive’ activity), and helped UK GDP grow by 0.1% in November. According to Darren Morgan, ONS director of economic statistics:

“The economy grew a little in November with increases in telecommunications and computer programming helping to push the economy forward… Pubs and bars also did well as people went out to watch World Cup games.”

The drastic fall in gas prices also helped to narrow the UK’s 3 month trade deficit by £6.5bn. However, it remains to be seen what lies ahead.

Persistent economic resilience and stubbornly high wage growth (from the Bank of England’s perspective, at least) increases the odds of further rate hikes.

On a yield differential basis, there’s a case for further convergence to perhaps squeeze an advantage in favour of GBP:

But it’s far from the obvious trade it was when UK yields were briefly higher than US yields and GBP was in the doldrums. There’s a big question of how higher rates will impact the property sector and the overspill to the rest of the economy.

The UK has a much larger share of variable rate or shorter-term fixed rate mortgages compared to the US, where most mortgages are long-term fixed.

For a typical US mortgage holder (as long as they don’t move house), payments are locked in at lower rates and their disposable income isn’t impacted by the change in mortgage rates. Sadly, a typical Brit doesn’t have that luxury, and the change in rates is likely to take a larger chunk of income once they remortgage.

Less disposable income is usually bad for consumption, and potentially also business investment, as companies anticipate the downturn. General sentiment among economists is that a UK recession is inevitable.

The UK’s plight is very much known. It’s hard to make the case for sustained GBP upside unless it’s fuelled by continued USD weakness. The pound has already weakened significantly against a resurgent euro in recent weeks, and EURGBP is running into key resistance levels now:

Is it time for the USD to push back against the EUR and GBP?