UK growth gets slammed in the fourth quarter:

The fourth quarter growth figures for the UK was worse than n some of the most bearish commentators had anticipated. The quarterly growth rate fell by 0.5 per cent, below the positive 0.5 per cent that the market expected. Although some of the slowdown can be attributed to the bad weather, the detail in the report was as dismal as the headline figure suggests. Construction, which held up so well in the second and third quarters, fell by more than 3 per cent, while activity in the services sector and the finance sector also contracted at the end of last year.

This does not bode well for the outlook for UK growth. Government and other services in the public sector saw total production actually rise at a faster rate in Q4 relative to Q3, at 0.9 per cent relative to 0.5 per cent. However, harsh public spending cuts have, by and large, yet to be implemented. UK Chancellor George Osborne immediately reacted to the news that growth contracted last quarter by reaffirming the deficit reduction plan. Without any slowdown in the planned cuts to public expenditure, the Government won't be able to act as a prop to growth going forward.

This is where the Bank of England comes in. In the past the Bank of England Governor Mervyn King has said that he is pleased by the UK's deficit reduction plans, although this caused some controversy. He has also hinted that the Bank will plug the growth gaps caused by the tightening of the fiscal screws. This reduces the chance of interest rate hikes, at least in the first half of this year, and vindicates the Bank's decision to remain on hold even as headline inflation creeps toward 4 per cent. The market is re-pricing its interest rate expectations for the UK, which is weighing heavily on the pound. It is down nearly 200bp in the past 2 days, and is currently trading below 1.5800. Due to the extent of the negative shock to UK growth, after such positive shocks in Q2 and Q3, the risks are to the downside, and we could see further declines to the 1.5600 level - the end of December lows.

However, as a caveat, these first statistics are liable to revision and we will have to see what signals other data releases in the coming weeks send about the outlook for the UK economy. Overall, this should leave the pound volatile at best in the coming weeks.

Although the UK has dominated the market this morning, there was a successful auction of Spanish short-term debt. Both 3 and 6-month bills saw yields fall relative to auctions held last month. However, the euro hasn't managed to extend its recent gains after falling below 1.3600 in the European session. Part of the reason for the decline has been the fall off in German bond yields. There are still peripheral issues that are unresolved, even if the picture is less bleak than it was at the end of last year. That limits the European Central Bank's ability to raise interest rates in the coming months. Hence, the tension between a strong Germany and a weak periphery should ensure that EURUSD doesn't move either higher or lower in a straight line.

The dollar index seems to be bouncing off support at 78 this morning, which is lending support to the dollar crosses and weighing on stocks and commodities that tend to move inversely to the dollar.

Ahead today the highlight will be US consumer confidence, the house price index and the Richmond Fed. But after the shocking UK data, the markets will wait to hear Mervyn King's speech this evening (1940 GMT) and tomorrow's minutes from the MPC meeting earlier this month. Could the market have been expecting too much hawkishness form the Bank? We will have to wait and see...

Data Watch:

 

14:00 GMT 0900 ET US: S&P/Case-Shiller home prices,) Nov -0.8

15:00 GMT 1000ET US: Consumer confidence index Jan 54 exp, 52.5 last

15:00 GMT 1000ET US: FHFA home prices, Nov 0.0% exp, 0.7% last

1940 GMT 1440ET UK BOE Governor Mervyn King speaks at event in Newcastle, England.

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

d: +44.(0).20.7398 5024 | f: +44.(0).20.7929.2010 | e: kbrooks@forex.com| w: www.forex.com/uk

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