[DanRath]

Q3 GDP was a large downside surprise for the market (-0.4% q/q versus 0.2%) and is a significant event for GBP. It matters because: 1) Further monetary easing at the November meeting is much more likely than it was previously, especially with the MPC appearing to be keener on erring on the side of caution. In addition, it delays the possibility of future rate hikes being priced in by the market. 2) The weakness of growth in the past two quarters was in sharp contrast to the survey evidence. 3) Weak growth exacerbates fiscal concerns: it both reduces receipts and increases payments. It also reduced the denominator in deficit/GDP calculations, the normal way to assess the fiscal stance. 4) It is bound to affect confidence. The press is likely to be quite vocal on this over the weekend.

All of this will likely weigh GBP in the near term.

However, there are a number reasons for the bullish GBP medium-term view: 1) The GBP is already at a very weak level in trade-weighted terms. More importantly, we still judge it to be undervalued relative to the EUR. 2) Data around the world continue to be encouraging. This still matters especially if the weakness if GDP was as a result of lower household sector demand due to a higher savings rate. Strong growth outside the UK will help the rebalancing process and means that GBP has to do less of the heavy lifting. 3) Commodity prices are increasing and the GBP has depreciated. This all spells further upside to UK inflation. If it continues to be surprisingly strong, the MPC may be forced to raise rates despite growth remaining weak. 4) The activity surveys suggest firmly positive growth for Q4, but what does that mean? The GDP numbers at this stage are unreliable and could easily be revised up.