The focus during the London session on Thursday is likely to be the UK GDP data for Q3 released at 0930 BST. The market is looking for a 0.3% pace of growth last quarter, which would keep the annual rate steady at 2.1%.
This GDP report is the initial reading, so it will not include the more detailed report that will be released next month, however, it will give us a key insight into how Brexit-inspired uncertainty is impacting the economy.
Could a decent quarter hold clues to a darker period ahead?
The market is looking for a 0.3% rate (as measured by Bloomberg). Interestingly, analyst opinions for Q3 GDP ranged from 0.5% to 0%. Thus, all analysts expected the economy to slow in Q3, after a decent 0.7% growth rate in Q2. While some may be pleasantly surprised by a 0.3% growth rate, at least it’s not recession territory; it could contain some hints of a much darker picture for the UK economy in the future.
We expect growth to be heavily skewed towards the consumer in Q3, as signs have already been growing that industry and construction have suffered in the aftermath of the Brexit vote. Industrial production has fallen sharply in recent months; it fell by 0.4% in August. Construction is facing a steeper decline, the latest Office for National Statistics data on construction output has fallen 2% since June. In contrast, the service sector PMI bounced back after a sharp decline in service sector sentiment in July. We expect this pattern to be repeated in the Q3 GDP report.
A herculean task for the UK consumer
As we have mentioned in previous notes, the UK consumer may be able to prop the economy up for now, but if wages are squeezed by rising inflation and unemployment then the all-important service sector may show signs of weakness.
Some may argue that the economic fears from Brexit have been overplayed, growth may have moderated in Q3 but it has by no means fallen off a cliff. This is misleading in our view, as the real impact from Brexit is likely to only show up in the economic data next year. The Bank of England has slashed its growth forecasts for 2017 to a mere 0.8%, compared with 2.2% for 2016. Consultancy firm PWC is forecasting a gloomier outcome at 0.6% for 2017. The biggest risk for UK growth is a sharp slowdown in business investment that could become more pronounced in the coming months, once the UK government has triggered Article 50. If the UK looks set to lose its access to the single market, then we may see the consumer show signs of stress, which could knock the UK economy seriously off course, and potentially plunge us into recession.
The market reaction:
We expect the market to remain fairly sanguine if GDP growth is inline with expectations, in fact, here could be a mini relief rally if GDP comes in at 0.3-0.4% as market anxiety over the impact of Brexit starts to recede. However, the more volatile move will come if we get growth at 0.6-0.7%, or below 0.1%. A better than expected quarter is likely to see a sharp rebound in the pound, which could break above 1.25 versus the US dollar, and trigger a move lower in EURGBP towards 0.80. A weaker than expected reading, could see another plunge in the pound, although we think a positive surprise would have a larger impact, since so much Brexit gloom is already baked into sterling.
The FTSE could be in for a shock if data disappoints
The FTSE 100 may be the more interesting UK asset class to watch on Thursday. A better than expected Q3 GDP reading could trigger a move to fresh record highs above 7, 129. However, a weaker reading could prove to be the canary in the coalmine for the FTSE 100, which has backed off recent highs of late.
The FTSE 100 has been remarkably resilient to Brexit fears, and has rallied on the back of a weak pound. If we see actual growth concerns start to surface then the FTSE 100 could be in for a rough ride. We may see downward pressure on domestic-focused companies including the Royal Mail and Sainsbury’s. Even the safe havens could struggle to attract inflows, as companies like Unilever and British American Tobacco start to look overvalued with P/E ratios above 20. The longer-term risk for the FTSE100 is that a weakened growth outlook at this stage triggers another wave of portfolio rebalancing away from the UK and towards Europe and the US. This could trigger a sustained move lower in the FTSE 100. But how far could it fall? Technical analysis suggests that the index will be at risk of further declines if it falls below 6,891, the 50-day moving average, the next key support comes in at 6,707, then 6,509, the 38.2% retracement of the February- October uptrend.
Overall, if Q3 GDP disappoints then we would expect UK equity investors to start to panic about the impact of Brexit, and for the FTSE 100 to begin to share the burden of negative UK economic sentiment with the pound.