Having seen the latest preliminary Q4 GDP numbers point to a 0.6% expansion, unchanged from Q3, the UK economy actually grew at a faster rate in the second half of the year than in the first half, despite all of the uncertainty caused by the vote to leave the EU at the end of the second quarter of 2016.

The numbers also pointed to how reliant the UK economy is on the services sector to the exclusion of other sectors of the economy, as construction and manufacturing lagged behind. There were encouraging signs though with construction expanding 0.1% in the final quarter, though manufacturing continues to lag behind.

There are encouraging signs on that front for Q1 if recent data from the CBI is any guide which showed that exports are growing at their best rate in two years, though there is some concern that rising prices in terms of input costs is likely to put upward pressure on inflation in the coming months.

The decline in the pound and the performance of the UK economy since the summer has raised the inevitable questions as to whether the Bank of England acted too hastily in cutting interest rates and adding stimulus at their August meeting.

While Bank of England governor Mark Carney has insisted that the central bank acted properly given the data at the time, there was an admission from Andrew Haldane, the bank’s Chief Economist that they had overestimated the shock effect that a vote to leave would have.

There is certainly an argument that the Bank’s actions at the time have exacerbated the decline in the pound given it was trading above $1.30 when they announced their stimulus program.

Since then the pound has been as low as $1.1950, and this is starting to be reflected in the latest input price numbers which in December saw a rise of 16% year on year.

This rise in inflation pressure has been acknowledged by bank officials and has prompted an admission from Mark Carney that MPC members are only likely to have a limited tolerance for high levels of inflation.

This week’s Bank of England rate decision and quarterly inflation report could well give clues as to how much tolerance officials are likely to have as the bank’s forecasters update their latest inflation and growth forecasts for the UK economy.

While financial markets have priced out the possibility of further rate cuts, with UK gilt yields now higher than before the August stimulus package, attention is now turning to when the Bank might conceivably raise rates and tapers its stimulus program.

Inflation expectations over a five year period are already ay 3.6% and with UK gilt yields at 1.5% there is a big divergence between the two. This is unlikely to be sustained in the long term given base rates are at 0.25%.

As it is the pound has already rebounded strongly from lows of $1.1980 this month, could an upgrade to inflation expectations propel it back to $1.3000?

 

CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.