In the UK, Q2 GDP data came out worse than expected, with a 0.7% q/q contraction. The consensus expectations were for a 0.2% q/q decline. Compared to the same period 1 year ago, the GDP contracted by 0.8%. The ONS indicated that the output of the production industries decreased by 1.3% in Q2 2012 (following a decrease of 0.5% between Q4 2011 and Q1 2012); the construction sector output decreased by 5.2% q/q; the output of the services industries fell by 0.1% q/q.
The reaction of the economists to this number was negative. Howard Archer at IHS Global Insight said to the telegraph online:
While part of the GDP contraction in the second quarter can be attributed to lost activity from the extra day's public holiday resulting from the Queen's Diamond Jubilee celebrations and to the very wet weather hitting retail sales and construction output, the economy's weakness clearly runs far deeper than that. This is highlighted by the fact that this was the third successive quarter of appreciable contraction, and the sharpest since the first quarter of 2009. The weakness of the economy is also highlighted by that fact that GDP is now 1.4% below the third quarter of 2011 and 4.5% below its peak level in the first quarter of 2008.
Following the release of the data, the Sterling weakened versus the Euro and, even if at a slower pace, versus the US Dollar.
In our view, the data may increase concerns between the investors that the Sterling is not a safe haven, especially for the European investors that want to diversify away from the Euro. Indeed, as signaled by the Q2's data, the UK economy will be negatively affected by the Euro zone recession. The IMF estimate of 0.2% rate of growth in 2012 and 1.4% in 2013 is at risk following the H1 data. Moreover, with the UK Government bond yields at an historical low, the performance of buying bonds - the outlook for the equity market is now negative as in the Euro zone - will depend almost completely on the Sterling trend.
In a medium-long term perspective, the major source of concern for the UK economy is the high level of debt, especially considering the Financial sector. Excluding the financial sector the total debt on GDP of UK is 305%, higher than in Germany (201%), Italy (286%), USA (282%) and in line with France 304%. However, considering the financial sector, the UK total debt/GDP skyrockets to 1047% of GDP, a situation hardly sustainable in the event of a crisis.
Moreover, the BoE may pursue an easing monetary policy in the months ahead to sustain the economic growth. In our view, the extension of the asset purchase program by GBP50bn to GBP375bn may not be the last one in the current easing cycle. The strong decline of the CPI in the last few months - the CPI fell from 4.2% in December 2011 to 2.4% y/y in June '12, with the trend expected to continue in the next few months - may help the BoE to further ease monetary policy in the months ahead.
For these reasons, to diversify away from the Euro we continue to prefer the U.S. Dollar, as we indicated in the article "Is The EUR/USD Heading Toward 1?"
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.