A Stronger Pound, UK GDP Data, Interest Rate Rises and Death to Zombie Companies

The UK economy continues to grow at a steady clip and commentators are becoming unanimous in their prediction for an interest rate rise at the Bank of England occuring within 6 months.

Interest rates are a tool used by policy makers to keep a lid on economic growth - strong growth inevitably leads to higher inflation which can cause catastrophic problems as time progresses.

The thinking goes that the Bank of England will raise rates to ensure the rate of economic growth is steady and healthy.

And for currency dynamics the rule applies that rising interest rates = rising exchange rates.

Therefore news released today that the UK economy grew at 0.7% over the last quarter is an all-out positive for the British pound exchange rate complex on the medium- to long-term time horizons.

The release of the data has inevitably seen a number of currency analysts cement their calls for an interest rate rise to be executed at the turn of the year.

“It’s a strong number: the economy is again growing at a rate above its potential and it will add to pressure on the BoE to increase the Bank Rate sooner rather than later. Indeed, in a recent speech Mark Carney attached great importance to GDP growth,” says Daniel Vernazza, Lead UK Economist with UniCredit Research.

Carney recently noted, “sustained growth above its past average of around 0.6 per cent per quarter” is one of three factors that are “worthy of particular attention in informing the timing, pace and degree of likely Bank Rate increases”. 

UniCredit continue to expect the first 25bp increase in the Bank Rate in November this year, around six months earlier than financial markets expect.

This is an all-out bullish scenario for the GBP, which if UniCredit are proven to be correct, will light a fire under the British exchange rate complex.

The Institute of Directors, who have become increasingly vocal in their call for higher interest rates, have urged the Bank of England to act sooner rather than later following today's GDP data.

In the wake of the release James Sproule, Chief Economist at the Institute of Directors, said:

“The Bank of England must now look closely at its interest rate policy. This is the latest piece of evidence which suggests the time to start normalising interest rates is now. An economy growing at 0.7 per cent per quarter, unemployment at just 5.6 per cent and real wage growth of more than three per cent has no need for historically low interest rates of 0.5 per cent.

"The IoD continues to call on the Bank of England to start the gradual process of normalising rates as soon as possible. We would like to see the Monetary Policy Committee vote for a 25 basis point increase when they meet next week.”

Insolvencies Fall, But Interest Rate Rise to Kill off 'Zombie' Companies

On Wednesday the good news out of the UK economy kept coming.

Official statistics showed that corporate insolvencies had fallen to pre-crisis levels once more.

This decrease was mainly driven by a decrease in compulsory liquidations, which fell to the lowest level since Q4 2013.

According to Brian Johnson, insolvency partner at the chartered accountants HW Fisher & Company interest rate rises could clear out any remainin under-performers:

"The army of "zombie" companies - which are essentially dead but continue to survive in suspended animation thanks to low interest rates and bank forbearance - is unlikely to ever return to rude health.

"These inefficient companies are likely to limp on for some time yet, but will be easy prey when interest rates rise."

Johnson says while the fall in corporate insolvencies is to be welcomed, but it shows only that fewer companies have gone to the wall - and tells us little about how many more fatally weakened firms are stumbling towards it.