Pound Sterling Advances as Economy Continues to Defy Gloomy Expectations

• GBP firm in wake of UK GDP release
• Economy grows in three months to Feb.
• But strike action weighed on output
• UK set to avoid recession, offers GBP some support

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The British Pound rose above 1.25 against the Dollar in the wake of UK economic growth data that confirms the UK economy is set to avoid recession in the first half of 2023, despite the impact of public sector strikes.

UK GDP was flat in February, underwhelming against expectations for the economy to eke out a 0.1% growth, as public sector workers downed tools said the ONS.

Disappointment was however curtailed by news January's growth estimate was revised up by the ONS to show 0.4% growth and altogether it is now clear the UK economy will expand in the first quarter of the year.

This provides a positive economic surprise for currency markets and the Pound to Euro exchange rate was higher in the wake of the figures at 1.1370, the Pound to Dollar rate was above the 1.25 barrier at 1.2516.

"GBP/USD is trading above all of its key daily moving averages and is supported by an upward-sloping trendline developed since early March. GBP/USD is now circa 3% higher year-to-date and nearly 4% above its 1-year average rate. The big question is whether $1.30 trades this year or whether $1.25 is the new ceiling?" says George Vessey, FX and Macro Strategist at Convera.

In the three months to February, the UK economy grew 0.1%, exceeding estimates for no growth at all. The Pound is 2023's best-performing major currencies thanks to a run of better-than-expected economic data outcomes, such as this.

"GBP is the 1Q23 surprise outperformer. After a disastrous 2022, when GBP/USD saw a >20% peak to trough decline, GBP is thus far the 2023 winner," says Skylar Montgomery Koning, Senior Global Macro Strategist at TS Lombard.

Driving the expansion in the UK economy is the service sector - which accounts for the majority of UK output - which expanded 0.1% in February said the ONS, exceeding estimates for 0%.

However, the UK's manufacturing and industrial production sectors remain unable to contribute to positive growth, with the former printing a flat 0% month-on-month reading for February and the latter -3.1%.

"While there is no doubt the UK economy remains under stress – recession probabilities are the second highest in G10 at 75% - the growth outlook has turned more positive," says Koning.

The UK economy finds itself defying expectations for a recession thanks to falling energy prices and "a more sensible budget" from the UK government, says Konging.

This meant that the economy escaped contraction in 4Q22 and will do so again in the first quarter of 2023.

"The result is that as consensus GDP expectations have been revised up, the economy has beaten them with economic surprises entering positive territory at the start of March," says Koning.

"GBP/USD upside pressure to persist," she adds.

Economic output might have been greater were it not for a number of strikes that occurred in February, say economists.

"Public sector strikes mask a private sector recovery," says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics. "Strikes by public sector workers weighed significantly on GDP in February."

Output in the private sector rose by 0.2% month-to-month in February, but this was countered by the drag of striking workers in the public sector.

Output in the education sector dropped by 1.7% month-to-month, subtracting 0.10pp from growth in GDP, says Tombs.

Output in the public administration and defence sector fell by 1.1%, subtracting 0.06pp from growth in GDP, due to strikes by many civil servants on February 1, he also notes.

"The big picture story is that today's release, combined with the revisions to economic activity, takes the three month growth rate to around 0.1%. The economy continues to stagnate, with economic activity struggling to grow beyond pre-pandemic levels," says Barret Kupelian, senior economist at PwC.

Jonathan Moyes, Head of Investment Research, Wealth Club says the GDP release will do little to change the gloomy outlook for the economy.

"However, if one were looking for positives in the data, unseasonably warm weather and industrial action were the chief drivers of lower growth, rather than a downturn in general business and consumer spending. The consumer, the construction sector and part of the services sector such as financial services appear to be in good health," he adds.