UK GDP Contracts in Q4, Economy at Risk of Triple Dip Recession

USD: New Cast of FOMC Votes Next Week
CAD: Killed by Weaker CPI
AUD: Gains Evaporate Quickly
NZD: No Surprises Expected from RBNZ
What Drove the Yen to Fresh Lows?

While the British pound dropped to a fresh 1 year low against the euro, it held steady against the U.S. dollar. The U.K. economy contracted by 0.3% in the fourth quarter, which was weaker than economists had anticipated. On an annualized basis, growth was flat making it clear that if not for the positive boost from the summer Olympics and the Queen’s Diamond Jubilee, the U.K. economy would be in much deeper trouble. If growth does not rebound this quarter, the U.K. would fall back into recession for the third time in 4 years. According to the GDP report, the manufacturing sector was hit the hardest with industrial production down 1.8%. On a quarter to quarter basis, construction activity increased but compared to last year, construction is down 11%. Prime Minister Cameron may be forced to look to the Bank of England for help especially as austerity weighs on growth. Between weak economic activity and missed budget reduction targets, the U.K. economy is prime for a sovereign debt downgrade by one of the big 4 rating agencies. A rough winter involving heavy snow and frigid temperatures puts the U.K. at risk of even weaker. If not for the increase in inflationary pressures, additional asset purchases by the Bank of England next month would be a given.

Cable sank to fresh session lows of 1.5745 in the aftermath of the release but managed to stabilize and recover above the 1.5750 level. Although the news clearly showed that the UK economy was very weak, the markets may dismiss the number as a one off event with the worst already behind it. The latest labour data out of UK was surprisingly robust and currency traders may be starting to bet on a recovery in Q1 thus providing a modicum of support for the pair after a massive selloff over the past several weeks.

Nevertheless, cable remains vulnerable to further downside pressures if the North American session decides to push the unit lower. For now the 1.5745 lows are holding but a break there could take us to a test of 1.5700 as sentiment toward the pound remains negative.

Meanwhile in Germany IFO index beat market expectations sending EUR/USD to fresh year to date highs as investors continued to bet on an economic rebound in the Eurozone. IFO printed at 104.2 versus 103.00 forecast while the expectations index hit 100.5 above 99.00 anticipated.

The positive reading comes on the heels of much better than expected results from the ZEW survey earlier in the week and stronger flash PMI data out of Germany yesterday showing clear evidence that the economic climate in EZ largest economy is improving as we start the New Year.

The news has given investors hope that the dour economic growth projections by the ECB may have been too pessimistic and currency markets pushed the EUR/USD through the 1.3400 ahead of the data and kept the rally going in the aftermath of the release as the pair targeted the 1.3450 level in morning European dealing. With EUR/USD now above the yearly highs the bulls will try to press their case towards the psychologically key 1.3500 barrier as the day proceeds.

All 3 of the commodity currencies extended their losses against the greenback with the Canadian dollar falling the most on a percentage basis. Canada was the only country to release economic data over the last 24 hours and according to the report, consumer prices remained at a 3 year low in the month of December. CPI fell 0.6% last month which left the annualized pace of CPI growth at 0.8% while core prices which excludes volatile items dropped from 1.2% to 1.1%. Lower inflationary pressures are one of the main reasons why the Bank of Canada said interest rate hikes were “less imminent” this week. Economic data has also been mixed with retail sales lagging despite strong job growth. Resistance in USD/CAD is at 1.02. In the past 48 hours, the AUD/USD has erased nearly all of this year’s gains. The sell-off was tipped by weaker Australian consumer price growth but the move could be getting a bit overextended considering that Chinese economic data has been good. More Chinese data is scheduled for release next week including the official manufacturing PMI report and if the government also reports stronger manufacturing activity, the AUD/USD could find support. The Reserve Bank of New Zealand has a monetary policy announcement next week – no surprises are expected as interest rates are set to remain unchanged at 2.5%.

The contents of this report are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The author(s) cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.

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