The Pound Sterling edged slightly higher after stronger-than-expected UK GDP data, but gains were limited as markets looked ahead to the inflationary impact of the Iran-driven energy shock.
0.5% UK Growth Beat Expectations of Stagnation
Solid growth in February was a pleasant surprise. However, the Iran war and subsequent energy shock may unravel the progress.
Markets have prices in two hikes from the BoE to deal with inflation, but ING point out they may not be necessary.
Markets are calm on Thursday after a breathless rally this week in stocks and risk assets as optimism grows over a US-Iran peace deal.
Currencies are mostly flat, with EURGBP still anchored at 0.87, while the US dollar is making a small bounce from new monthly lows made earlier in the session.
Data is again on the light side, but the GDP release in the UK caught some attention as it showed solid growth when stagnation was expected.
UK GDP Posts a Strong Beat
The latest headlines from this week’s UK GDP report show that the British economy grew by 0.5% in February, significantly surpassing the consensus estimate of 0.1%.
This represents the strongest monthly expansion since early 2024 and suggests the UK was gaining genuine momentum just before the outbreak of the Middle East conflict.
Additionally, January’s figure was revised upward from stagnation to a 0.1% increase, further reinforcing the image of an economy on a much firmer footing than previously feared.
However, we must acknowledge that these details are largely historic, as they predate the massive energy and shipping shocks currently reshaping the global outlook.
The growth in February was broad-based, with the services sector expanding by 0.5% and manufacturing output also rising by 0.5%.
Construction was a particular standout, rebounding by 1.0% in the month.
Despite this across-the-board strength, economists warn that this momentum was likely “extinguished” by the sudden surge in oil prices and the naval blockade in the Gulf, which occurred immediately after this data period.
The reaction in the currency markets saw Sterling rise slightly as the data beat fueled expectations that the Bank of England may keep interest rates higher for longer to manage inflation.
In the bond market, UK yields remained elevated, with the 10-year Gilt yield reflecting the decreased likelihood of near-term rate cuts following such a “sizeable” expansion.
High-profile analysts have been quick to point out the disconnect between this data and the current reality.
Ruth Gregory, deputy chief UK economist at Capital Economics, noted that the “bumper” growth in February was “probably already extinguished” by the start of the Iran war.
Looking ahead, the market’s focus has already shifted from these historic gains to the looming “energy squeeze” expected in the second quarter which is encouraging market expectations for BoE cuts.
However, ING point out that the inflationary shock may not be as bad as feared:
“Financial markets are still applying the 2022 playbook to the Bank of England. The scale of repricing in interest rate expectations has been more dramatic than either the eurozone or the US. The implied UK rate one year from now has risen a full percentage point since the onset of war, and investors are still pricing close to two hikes by year-end. That seems to imply that the UK is facing a more severe inflation shock than elsewhere. We disagree.“
2022 was driven by surging energy costs, especially gas prices.
They have risen lately, but nothing like they did in 2022. Furthermore, inflation is unlikely to rise like it did then for other reasons as the labour market is much cooler and there is less corporate pricing power.
This suggests the BoE will not raise rates as much as the market currently expects, and that may come back to haunt the pound if hikes get priced out again over the summer.
