Uncertainty in Euroland, but Britain’s GDP on the rise

On 27 August the Office for National Statistics published its first revision to the performance of Britain’s gross domestic product (GDP) for the second quarter of the year. The initial estimate of 1.1% growth had looked pretty good. It was not in the same category as Germany’s humungous 2.2% expansion but better than Euroland as a whole at 1.0% and way ahead of America’s 0.6% or Japan’s pitiful 0.1%. The late August revision was better still, suggesting the UK economy had grown by 1.2% in the second three months of the year. Rejoice! So why was it that the first reaction of investors was to sell the pound? They only took it half a cent lower against the euro and it soon recovered but why did they sell it at all? Surely it was a good thing for the pound if Britain’s economy grew by 1.2% between March and June?

Indeed it was, but investors are far from convinced that there will be a repeat of that performance any time soon. In fact they are convinced that the second quarter GDP figure will be a watershed. From here on in, Things Can Only Get Worse. It’s the Austerity Budget wot done it; that’s the view on the street. Spending cuts will hit every sector of the economy. Fewer consultants will be hired. Fewer policemen will fill in forms. Fewer speed cameras will collect revenue. Fewer pot plants will be bought or rented to grace departmental desks. The list goes on. It will mean less spending by the country as a whole and an erosion of GDP. Some say it will mean a return to recession, the dreaded double-dip.

That gloomy outlook has cast a shadow over what would otherwise have been a good run for the pound. After all, it is not as if the euro zone is without its problems. Those problems have not been in the headlines exactly, since the Greeks stopped blowing up banks and blocking the country’s borders a couple of months ago, but they have not gone away. Three months ago the EU trumpeted the creation of a Europe-wide financial safety net that would protect Greece (and others) from bankruptcy. German taxpayers did not like it one little bit at the time but Frau Merkel gave them their marching orders and they paid up to salvage the euro. Since then the rebellion has spread. Spain is considering relaxing its own austerity regimen in order to stimulate the economy. Slovakia has said to the EU that it ‘Can’t pay, won’t pay’ to support a country (Greece) that has chosen to blow its inheritance. The latest inequity is the downgrade of Ireland’s credit rating. Because of it, Ireland will have to pay some 5.25% interest on 10 year government debt. At the same time, through the EU, Ireland will be paying to hold down the Greek government’s cost of borrowing at 5%. Some say it is not fair that the prudent subsidise the spendthrift. Whether these cracks ever result in irreparable damage to the euro is up for grabs. Most analysts say they will not but the risk remains.

So we have the fiscally-responsible British government committing the country to a century-long depression and the fiscally-irresponsible southern European states condemning the euro to a sovereign debt implosion. The euro and the pound are both obviously doomed. Obviously not, but from investors’ point of view the risks are more or less evenly balanced at the moment. Sterling was the winner in August, adding a cent and a half , but it has been finding it tough going above €1.22. Given the uncertainty, there is no reason not to manage one’s exposure to sterling/euro with the traditional hedge, fixing a price today for half the currency needed in the future. The argument applies to buyers of the pound and buyers of the euro alike.

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This entry was posted on Friday, August 27th, 2010 at 3:11 pm and is filed under Currency exchange, Finance, Money transfer . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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