British Pound: Growth distortions and rate risks – Commerzbank

Commerzbank’s Michael Pfister highlights unusually strong UK growth in the first quarter and weaker outcomes later in the year, driven largely by services. He argues this seasonal distortion complicates Bank of England policy signals, limiting conclusions from July’s robust data. With markets increasingly pricing rate hikes, lingering uncertainty on underlying momentum creates scope for disappointment and downside risks for the Pound.

Seasonal growth pattern clouds Pound

"The UK's exceptionally strong growth figures, published on Friday, came in at 0.4% month-on-month. Such figures at the start of the second half of the year have not been commonplace in recent years. After all, a remarkable phenomenon has been observed since 2022. After seasonal adjustment, one would usually expect all quarters to show similar growth rates. Since 2022, however, the situation in the United Kingdom has been different, with exceptionally strong growth observed in the first half of the year and particularly weak growth in the second."

"It may not be clear at first glance why this trend is relevant to the pound. We usually argue that stronger growth is generally positive for a currency because it makes interest rate hikes more likely and due to a portfolio effect. But monetary policy does not usually react to a single data point, and policymakers are likely to be well aware of the variations in quarterly growth."

"To assess the implications for UK monetary policy - and thus for the pound - we must first understand why these distortions are occurring. One possible explanation is that seasonal patterns have changed, and established seasonality adjustment methods such as x13 ARIMA do not recognise these changes quickly enough. The pandemic, for example, would be an obvious reason for a change in these patterns."

"If growth seen in July continues into the coming months, this will likely prompt the Bank of England to consider interest rate rises. Until then, however, uncertainty about the underlying growth momentum is likely to further reinforce the Bank of England's cautious stance on interest rate rises. As the market has recently been betting more heavily on rising interest rates, there is a corresponding potential for disappointment and thus downside risks for the pound."