Sterling slammed on weak UK GDP; BoE King speech due

Tue Jan 25, 2011 10:31am GMT

Related Topics

* UK Q4 GDP suffers shock contraction, pound slides

* Sterling falls over a cent vs dollar, down 1 pct on day

* MPC Governor King speech at 1900 GMT closely watched (Recasts, adds quotes, detail)

By Neal Armstrong

LONDON, Jan 25 (Reuters) - Sterling plunged on Tuesday after a shock contraction in fourth quarter UK GDP data, pushing back the chances of monetary tightening by the Bank of England in the near future.

Britain's economy shrank 0.5 percent in the last three months of 2010, bucking forecasts for a 0.5 percent expansion, with December's heavy snow accounting for only part of the first contraction in five quarters, official data showed on Tuesday. [ID:nLDE70O0VC]

The figures will be bad news for the government which is due to start cutting public spending in earnest early in 2011, and will cast doubt on market expectations that the Bank of England will raise interest rates in the first half of the year.

"Sterling has been clobbered on the data which was very much weather-distorted, but even if you take that into account it's disappointing. This supports the thinking by the BoE's Adam Posen that all is not well in the UK economy," said Paul Mackel, Director of Currency Strategy at HSBC.

Sterling fell by more than a cent versus the dollar GBP=D4 to a session low of $1.5770, down around 1.4 percent on the day. Traders said an Asian sovereign account was looking to buy the pound around its lows.

The euro EURGBP=D4 rose around 50 pips to trade above 86 pence for the first time in three weeks, hitting a session high of 86.16. A UK clearer had been reported as the main euro buyer in early trade.

Short sterling interest rate futures from June 2011 out were as much as 20 ticks up on the day. <0#FSS:>

"While today's GDP figures are backward-looking, they are nevertheless crucial to understanding the resilience of the economy to shocks. It seems that the economy is incredibly vulnerable. And with the fiscal tightening yet to fully bite, we will have to brace ourselves for a bumpy ride," said Hetal Mehta, economist at Daiwa Capital Markets Europe.

Separate ONS figures showed that Britain's public sector net borrowing rose from a year ago to its highest December reading on record, though it fell from the all-time record reached in November. [ID:nAHLOCE7CI]

Sterling had been supported through most of January as market expectations of higher UK interest rates grew. Surprisingly high UK CPI data for December released last week had illustrated persistent inflationary pressures in the economy.

This presents a dilemma for the Bank of England, which now has to juggle a worrying outlook for growth combined with elevated price pressures.

BOE KING SPEAKS

BoE policy hawk Andrew Sentance pointed firmly to one side of the Bank's dilemma on Monday evening, saying that the factors pushing up British inflation cannot simply be dismissed as "one-off" influences and that the bank risks losing credibility if it fails to respond.

In comments which highlight his disagreement with BoE Governor Mervyn King -- who is likely to use a speech on Tuesday evening to argue price rises are under control -- Sentance said inflation risked becoming entrenched and a gradual tightening of policy now could prevent a more aggressive move later on. [ID:nLDE70N2C5]

Posen, the most dovish member of the bank's Monetary Policy Committee, has argued that spare capacity in the economy would keep a lid on inflation. In October he called for more stimulus to ward off the threat of a prolonged period of economic weakness. (Editing by Susan Fenton)

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