© Ross Walker
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After a long slowdown, Britain's economic growth bounced back to its pre-crisis state, as the data released last Tuesday showed UK's GDP rose 0.7% in Q2, following a rise of 0.4% in the first quarter. The services sector boosted the growth as manufacturing declined, prompting warnings from economists that the recovery is being fuelled by a two-speed economy. What do you think, is the UK economy now on a healthy trajectory?
My point of view is that the economy is growing, but it is not obviously growing above trend. Hence, if you look at GDP, excluding North Sea oil and gas, which traditionally has been the MPC's preferred measure, that makes sense, because oil and gas from the North Sea can be very volatile.
However, if we look at industrial production numbers, we see that it has been up 1%, but all of that was North Sea oil and gas, so manufacturing has actually contracted. The GDP, excluding oil and gas, grew by 0.4% in Q1 and 0.5% in Q2. Thus, those are sub-trend items, which means that the margin of spare capacity in the UK economy has increased over the course of this year. Vice of that, I do not understand what this additional pressure is. Some people seem to detect only the MPC to raise rates soon.
Improved economic growth has added calls for a rise in interest rates by the end of the year. Do you expect a rate hike to take place this year?
I do not expect a rate hike from the BoE this year. I suppose the bank will keep the door open on November 2015, whereas, my forecast for the first rise is for February 2016. Even around that, I think that there are certain risks, but the move comes later, and due to that the Bank of England will be data-dependent.
Some of the guidance they give us at the moment has a time contingent dimension to it, not that we get closer to a rate rise that becomes more important, but, ultimately, it will depend on the state of the economy. Moreover, a number of macro indicators suggest some loss of momentum in the global economy, and as we discussed, the UK economy this year has not been growing at above trend rates, so that would determine the timing of the policy decision.
What will be the major drivers for the Pound until the end of 2015?
I believe that there are important factors such as the UK's relative safe-haven status that will continue to provide a prop, however, it is about the monetary policy and the expected interest rate differentials.
Most central banks in the developed world are either easing policy or are signalling unchanged policy settings. The exceptions, of course, are the Fed and the BoE. Therefore, if the BoE is to raise interest rates ahead of the US Fed, the Sterling is going to rise significantly. The currency here is already at levels, which are beginning to pose some difficulties for parts of the UK export sector. We have not had any significant boost to GDP growth from net exports, so further currency appreciation does bring risks and potential problems.
In addition, the exchange rate appreciation that we have already seen, with some additional 3% to 3.5% since the May inflation report will be doing a good work for the BoE , in terms of the dampening effect on the UK demand. I believe that the difficulty with the exchange rate raising is that you are dampening parts of the economy you do not want to, namely, the export sector. Hence, I think that the BoE needs to proceed quite cautiously in raising interest rates, or at least sound like it, in order to prevent further significant appreciation of the currency.
What are your forecasts for GBP/USD and EUR/GBP for the same period?
Overall, our forecast for the GBP/USD will be largely stable over the next few months, not so much of the remainder of this year. I suppose, if the Bank of England was to tighten ahead of the Fed, we would have a rise, but considering that the US Fed begins to normalize policy settings, we would see the Dollar recovering. Fundamentally, we are still even at these levels, relatively bullish on the US Dollar.
In terms of medium-term view, we see the Cable down to around 1.47 by the middle of next year. For the EUR/GBP we have broad stability. I think the Pound will continue to gain moderately against the Euro, so by the middle of next year we have the EUR/GBP at around 69 cents.