The Aussie upside to a sterling recovery

A resurgent UK economy has not yet translated into productivity or wage growth, and while the BoE grapples with the effects of a higher pound, Australian exporters should benefit.

The UK economy expanded at a solid pace in the December quarter, but the Bank of England is unlikely to raise rates anytime soon. Improving growth prospects and a much stronger pound could prove beneficial to Australian exporters in the year ahead.

UK real GDP rose by 0.7 per cent in the December quarter, meeting market expectations to be 2.8 per cent higher over the year. Annual growth rose to its highest level since the onset of the global financial crisis but the UK economy remains 1.3 per cent below its peak in the March quarter 2008.

Graph for The Aussie upside to a sterling recovery

The pace of growth has picked up throughout 2013 and should continue at a solid pace during 2014. Services, which make up more than three-quarters of GDP, rose by 0.8 per cent in the December quarter to be 2.7 per cent higher over the year.

Growth was similar for production, which increased by 0.7 per cent to be 2.7 per cent higher over the year. Production has now grown for four consecutive quarters, following declines totalling over 6 per cent during 2011 and 2012. Every category of production rose in the December quarter, with the exception of mining and quarrying.

Construction fell by 0.3 per cent in the December quarter but that was not unexpected, following particularly strong growth in the June and September quarters. Agriculture rose by 0.5 per cent in the quarter but still has a long way to go to wind back the losses experienced over the past few years.

The data itself is preliminary and based on incomplete data for the December quarter. Historically there have been revisions and, if GDP is revised up over the next couple of months, it will indicate that the economy strengthened further throughout the quarter.

Growth has been supported by an improving labour market, which has surprised the BoE and most market analysts. In August, the central bank expected the unemployment rate to get back to 7 per cent by early 2016. Instead, employment may have reached that target by next month.

So far, this hasn’t translated to stronger productivity growth or wage growth. A third of those remaining unemployed have been unemployed for over 12 months. The labour market is stronger than it has been since the global financial crisis began, but I wouldn’t characterise it as particularly strong. In truth, it is a labour market that is consistent with an improving economy that continues to produce less than it did six years ago.

When framed this way, it makes sense that BoE governor Mark Carney believes there is no need to raise rates anytime soon. Based on his public statements, we are unlikely to see a rates rise until at least late 2014 but probably in early 2015 – unless inflationary pressures rise unexpectedly.

For Australia, improving growth in a trading partner – albeit an increasingly less important one – is always welcome. The British pound continues to appreciate against most major currencies, rising by more than 10 per cent against the Australian dollar since the end of October and almost 25 per cent since March last year. Dreadful news for Australians looking to go on a holiday, but welcome news for exporters and tourism.

Merchandise exports to the UK took a big hit following the onset of the global financial crisis and the increasingly strong Australian dollar. Improving UK growth prospects and the sharp depreciation in the Australian dollar could help partially reverse that.

The rising currency is a key concern for the BoE, which would naturally prefer the currency to remain low and support export growth, but it reflects an economy that has become stronger in recent quarters and is performing better than its major trading partners in Europe. Given the BoE’s reluctance to raise rates – which is entirely understandable – a strong pound is just something they will have to get used to.

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