GDP declines in UK

(26.01.2011) British GDP contracted in the forth quarter of 2010 due to heavy snow. As a result the GBP weakened significantly yesterday. In his State of the Union address, Obama seeked bipartisan efforts in spending freeze. Today we have two interesting interest meetings, in the US and in Norway.

By Camilla Viland, Analyst at DNB Markets

dealingroom DNB markets ccDue to heavy snow the British economy contracted unexpectedly, by 0.5 per cent in the forth quarter of 2010. Consensus had expected the economy to grow by 0.5 per cent. The ONS said that it was likely that the bad weather had contributed to most of the quarterly fall. Growth would probably have been flat otherwise.

However this first estimate of GDP growth only covers about 40 per cent of the economic activity which will be included in the more mature estimates published around 12 months later. The historical revisions have generally been relatively small, and have mostly been upward. Even if there are some uncertainties surrounding yesterday's data release, the figures are clearly on the weak side. The development is worrying, and going forward the effect of fiscal tightening is likely to start affecting growth negatively.

The figures also highlight the dilemma the British central bank is facing; Weak growth on one hand and inflation above target on the other. We believe the central bank should see through a period of high inflation and keep interest rates at current low levels. Yesterday's figures support our view. The British pound weakened significantly after the preliminary GDP figures were released.

In his annual State of the Union address, Obama called for cooperation across political parties to "do big things". He said whether new jobs and industries would take root in the US or somewhere else where at stake. Furthermore he proposed a freeze on non-defense discretionary spending that would save USD 400 billion from the budget over the next decade. He also approved of additional cuts of USD 75 billion in the defense budget. More details about he spending plans will be revealed mid- February when the president submits his budget blueprint for fiscal year 2012. Treasury prices rose as a result of the news.

US key figures have generally been on the positive side the last month, a fact which the press release following tonight's interest rate meeting in the Federal Reserve is likely to reflect. However, a lot of emphasis is likely to be given the weak labour market. This is an important reason why interest rates are likely to be kept at current low levels throughout 2011. According to the minutes from the central bank's December meeting, members emphasized that the pace and overall size of the purchase program would be contingent on economic and financial developments; however, some indicated that they had a fairly high threshold for making changes to the program. Thus, we do not expect any changes in QE2 at this meeting.

The Norwegian central bank (Norges Bank) also meets today. Their latest interest rate path indicates that interest rates will be kept on hold until the summer. Since Norges Bank's last meeting both international and Norwegian interest rates have gone up and the Norwegian krone has strengthened. In total market developments should not affect assessments of future interest rates significantly.

The economic development in Norway has confirmed that the economy is heading towards normalization. Consumption has been somewhat stronger than expected and house prices have clearly surprised on the upside. The central bank has previously stated that the consideration of guarding against the risk of future financial imbalances that may disturb activity and inflation somewhat further ahead suggest that the key policy rate should not bee kept low for too long.

We do not expect the central bank to address this issue now, but this may be a topic when they release their next monetary policy report, in March. If house prices continue to rise, interest rates may be hiked sooner than what the current interest rate path indicates. If so, the Norwegian krone may strengthen.