The horrible UK Q3 GDP data (-0.4% q/q) have scuppered hopes that the UK economy has already pulled itself out of recession.  Following the squeeze higher in the pound that commenced last week, sterling was particularly vulnerable to the bad news.  Cable plummeted back to 1.6417 before support became to emerge; EUR/GBP has soared up to 0.9160.  EUR/GBP had earlier ignored the better than expected Eurozone PMI data and the decent performance of the German IFO (87.3 in Oct).  These data support the view that in contrast to the UK, the recovery in the Eurozone remains on track.  Good news from the Eurozone has helped support risk appetite this morning.  While stocks pared their gains following the UK data, indices are mostly higher and this helping to keep EUR/USD above the 1.500 level.

From a policy point of view the UK GDP data firmly put the risk of more quantitative easing back on the table for the November MPC meeting.  Yesterday's poor UK retail sales data failed to have a lasting detrimental impact on the pound although these data should have been a warning of the poor economic environment which is continuing to weigh on consumer activity.  The release early this week of the minutes of the October meeting including recognition by the BoE that condition had improved.  While sterling rallied on this statement and on the news that all members of the committee voted in favour of no change in rates and on the news that they saw ''no pressing reason'' for a rate change, this should not have surprised since the prospect of more QE was never really expected for October; the Bank had previously indicated that this decision was more appropriate in November given the coincident publication of the Nov Inflation report.  Although near-term inflation expectations may be revised higher in the Inflation Report, the Bank will likely see medium-term inflation still under pressure from plenty of excess capacity and this should provide the freedom to increase the monetary stimulus in Nov and maybe beyond. 

The prospects for UK Q4 GDP will be supported by the VAT hike due on Jan 1 2010 which is likely to lead to some front-loading of expenditure.  That said, expect UK economic potential to be dampened for some time by rising unemployment, higher savings rates and the expected reining in of fiscal stimulus.  Given that economic data from German and France this morning have suggested the Eurozone recovery remains on course, sterling could maintain its very weak footing vs the EUR for many months.  Technically, cable looks to be on course for a move towards the 1.6400/10 congestion area.  Below may see to 1.6360.  EUR/GBP should run into some resistance at 0.9150, above may see to 0.9190.