British Pound Finds Support as June GDP Data Beats Expectations, but Sharp 1st Half Recession Confirmed

- GBP holds 1.11 against EUR, 1.30 against USD
- GDP grew 8% in June
- But UK suffers sharp recession in 1st half of 2020

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Pound Sterling was seen holding above key levels against the Euro and Dollar following the release of official data that confirmed the UK economy had officially fallen into a deep recession in the first half of 2020 but had started to rebound strongly in May and June, with economists saying the July-September period should see the rebound gather pace.

GDP statistics from the ONS shows the economy shrank 20.4% on a quarterly basis in the second quarter, which makes for two consecutive quarters of decline which is the standard economic condition for a recession to be declared.

The annual GDP rate stood at -21.7% for the second quarter, which was slightly better than the -22.4% analysts had forecast the ONS to report.

Another key economic reading released by the ONS alongside the GDP figures was the Index of Services - which is a measure of activity in the UK's dominant services sector - which read at -19.9%, which is slightly better than the -20.5% markets were expecting.

However, the more timely element of the report shows the economy grew 8.7% in June, which beat economic estimates for growth of 8.0% to be reported, and confirms a recovery is now underway.

For foreign exchange markets it is this more timely element of the report that will be of interest, indeed a key driver for foreign exchange markets into year-end will be the speed and size of an economy's recovery relative to others, with the currencies of those economies enduring a strong recovery likely to outperform.

On this basis, the UK does start from a position of weakness against the Eurozone which recorded a 12.1% slump in GDP and the U.S. which recorded a 9.5% decline. 

From a pure foreign exchange perspective, what happened in the first half of 2020 is now firmly in the rear view mirror and what counts for Sterling is what happens in the second half of the year.

"Comparisons to previous recessions are not particularly illuminating. Firstly, the 20.4% contraction in Q2 was caused by active shuttering of the economy which has since been reversed - hence we are likely to see a faster recovery of much of that activity than in, say, 2009. The 8.7% monthly jump in June supports this. Secondly, the Government’s furlough scheme has greatly delayed the labour market shock you’d associate with a recession of this magnitude, in the hopes of lessening long-term impacts to consumer behavior due to job losses," says Ranko Berich, Head of Market Analysis at Monex Europe.

Industrial production meanwhile fell 12.5% in the year to June, but in the month to June a sharp rebound of 9.3% was recorded, suggesting a recovery in the sector is now underway.

Manufacturing production in the month to June meanwhile rose 11%, which was better than the 10% analysts had forecast.

In fact, all the key readings came in above market expectations which could be interpreted as being net positive for the British Pound:

The Pound-to-Euro exchange rate is quoted at 1.1190 at the time of writing, the key figure here to watch is support at 1.1111 which looks to be holding for now. The Pound-to-Dollar exchange rate is meanwhile at 1.3045, the key figure here to watch is the psychologically significant 1.30 threshold.

"The rebound in economic output in June is likely supporting the pound though, but the fact that the pound is a risk-friendly currency is also helping it stay afloat amidst global recovery optimism and vaccine hopes," says George Vessey, UK Currency Strategist at Western Union.

Above: Sterling is the best performing major currency of the past month.

"For now markets have taken this morning’s figures in their stride, with the figures largely confirming what most had expected and with investors more focused on prospects for recovery well beyond the end of Q2. Indeed, sterling currently stands at $1.3045 from $1.3033 just ahead of the numbers," says Victoria Clarke, an economist at Investec.

(If you would like to book current GBP rates in anticipation of a fresh decline, or would prefer to order a rate automatically when the market rises to hit it, please reach out to our partners at Global Reach who would be happy to assist.)

Looking ahead, all signs point to the economy making a strong start to the second half of the year, particularly now that pubs, hospitality providers and restaurants reopened in July.

"With social distancing rules eased further last month, a number of signs point to the UK economy making a strong start to Q3, with business activity surveys and fast indicators pointing to firmer trends. This should mean that the recession seen in the first half of the year – due to Q2 GDP dropping 20.4%, following a fall of 2.2% in Q1 – almost certainly proves short lived," says Nikesh Sawjani, UK Economist at Lloyds Bank.

"We think the Q3 bounce will be more dramatic with activity data already up markedly over the summer," says Sanjay Raja, Economist at Deutsche Bank. "The economy's slump ended in May. Both May and June GDP bounced, erasing some of the 26% drop between February and April. As things stand, the economy is now 17% below its pre-virus levels - slightly better than we expected."

The Pound's outlook for the remainder of the year rests heavily with how the Bank of England responds to the economic revival over coming months, with any disappointment in growth likely to be met with further quantitative easing measures and further suggestions that interest rates could be cut to 0% or below.

Such developments would typically be expected to weigh on the currency.

"It is likely that both the Bank of England and UK government are likely to remain highly sensitive to any signs of faltering in the recovery. As such, the likelihood of further stimulus measures being deployed remains high, especially with the outlook challenged by a number of risks – including those stemming from the labour market (as the furlough scheme is wound down) and those associated with a further pick up in Covid-19 cases," says Sawjani.

A significant concern for currency analysts and economists is the impact the ending of the government's furlough scheme will have on the economy, with many suggesting the UK's relatively benign employment figures out yesterday will likely deteriorate when it ends in October.

"One key challenge is keeping the economy from losing momentum in the later part of the year and in the early part of 2021. The headline unemployment rate, unmoved from its pre-pandemic position, is not reflecting the full extent of the disruption in the jobs market, amidst a rise in inactivity," says Clarke. "As we approach the end of the furlough scheme which concludes at the end of October, a rise in unemployment (and potentially more inactivity) appears likely."

Investec expect to see both of these forces weighing down on consumer momentum somewhat, while incessent warnings of a severe second wave of the coronavirus persist and bring with them a prospect of wider lockdowns during the winter creating a further impediment to recovery.

"This is something the Chancellor appears to have been weighing in recent days amidst reports he is considering the option of delaying his autumn Budget to a later point, if a big second wave arrives," adds Clarke.