"Sterling is Surging" as NIESR Forecast UK Economy Bounce-Back, Future Gains Seen v Euro and US Dollar

• Pound to Euro exchange rate today: 1 GBP = 1.1183 EUR, day's high: 1.1190, low: 1.1153
• Pound to Dollar exchange rate today: 1 GBP = 1.3231 USD, day's high: 1.3244, low: 1.3190

Britain's longest established independent research institute - the National Institute of Economic and Social Research - have announced they expect the UK economy to see increased growth rates in coming months.

The organisation's latest set of economic forecasts project 2017 growth to be at 1.7% which implies increasing growth in each coming quarter if we consider the catch-up the economy must achieve after the 0.2% and 0.3% growth rates delivered in the first and second quarters of this year.

Furthermore, growth in 2018 is expected to stand at 1.9%.

We believe this spells potential upside for the British Pound as this kind of economic growth is not being factored by the markets.

“Sterling is surging towards its highest mark since last September, which is pretty surprising when you consider the recent downgrade to growth estimates by the IMF. However, fresh forecasts from the NIESR suggest we could see a notable uptick in the UK economy in the second half of this year and that’s heightened buying interest," says Dennis de Jong, Director at UFX.com.

The NIESR believe the Bank of England will have to respond to this growth with an interest rate rise - and we read this as being positive for the Sterling.

Market are not factoring in the kind of growth expected by the NIESR, and nor are they factoring in an interest rate rise at the Bank of England anytime soon.

Therefore, market expectations will have to rise, and the Pound will likely be taken higher as a result as the currency is a key expression of market expectations regarding future interest rate levels.

It is important for readers to note that this is a longer-term, multi-month, theme when it comes to Sterling.

“It is a gentle increase over the next few quarters,” said Amit Kara, Niesr’s Head of UK macroeconomics research at NIESR regarding the UK’s potential growth trajectory.

Kara says the Bank of England, “should withdraw some of that stimulus in six or eight months’ time, if the economy evolves as we forecast, which is with further strengthening in growth".

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Economic Growth Higher, Inflation Lower

The economy expanded by 0.3% in the second quarter of 2017 according to official statistics.

The outturn was in line with the Institute’s nowcast and slightly faster than the 0.2% growth in the previous quarter.

NIESR’s forecasts for GDP growth for this year and next remain unrevised at 1.7% and 1.9%, respectively.

“The economy has slowed each year since 2014 and according to our forecast, 2017 will mark the trough for GDP growth. Thereafter, we envisage a modest recovery that takes economic growth to a level that is close to potential,” says Kara.

Inflation, as measured by the consumer price index, is set to increase further, from 2.7 per cent in the second quarter of 2017 to 3 per cent in the final quarter, before easing back to the target rate of 2 per cent in the final quarter of 2019.

The NISER’s forecast for CPI inflation however, is lower compared with that in their May Review because the outturn for the second quarter was weaker than our forecast.

Inflation is forecast to peak at 3.0% in 2017 and fall back to 2.4% in 2018.

“Notwithstanding the downward revision to the inflation forecast, we have brought forward the timing of the Bank Rate hike from the second quarter of 2019 to the first quarter of next year,” says Kara.

This would be the first policy rate increase in nearly eleven years.

“This rate increase should not be seen as a tightening in policy, but instead as a modest withdrawal of some of the additional stimulus that was injected into the economy after the 2016 EU referendum,” says Kara.

This thinking backs up the views of Bank of England Chief Economist Andy Haldane who raised eyebrows in June when he suggested a 0.25% interest rate rise at the Bank was appropriate.

Many had reckoned Haldane to be on the more cautious end of the spectrum and would therefore shy away from raising interest rates.

But Haldane’s argument was that the 0.25% cut delivered in 2016 should be withdrawn; Pound Sterling found support on the view and could find further support if this idea gains traction over coming weeks.

The Bank of England’s August policy decision and inflation forecast due on August 3 will therefore be pivotal in terms of how the Bank is thinking on the matter.

UK Manufacturing Data Signals Strong Pick-up in Activity

Latest data out of the UK economy confirms the manufacturing sector continues to see expansion as demand for UK exports expands.

IHS Markit and the CIPS reported at the start of the new month that their Manufacturing PMI survey reveals an acceleration in activity in the sector with a reading of 55.1 being reported for July, up on the previous month’s 54.2 and ahead of economist forecasts for 54.4.

The headline PMI was boosted by stronger inflows of new work, higher levels of production, improved job creation, longer supplier delivery times and a slight increase in inventory holdings.

However, the same optimism is not being reflected in the construction sector as the July construction PMI confirmed a slowdown with a reading of 51.9 suggesting the sector is just about growing.

Markets had forecast a reading of 54.5.

This represents the weakest construction performance since August 2016 as commercial work fell the fastest in 12 months. New orders were seen declining with job creating also falling.

"Commercial building activity slowed for the first time in five months and was the main drag on the Index. Housing, the shining light of the sector eased marginally, but produced the slowest growth since April, as parallels with the darker days of Brexit, worries about the UK economy and post-election uncertainty can be seen across the construction sector," says Duncan Brock, Director of Customer Relations at the Chartered Institute of Procurement and Supply.