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Weak UK GDP Sets Scene for Further QE

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The recent Q4 GDP numbers, while disappointing, weren't that much of a surprise given the weakness of some of the recent economic data, especially in respect to industrial and manufacturing production.

It is also worth noting that this is the first estimate of GDP, at -0.2% will no doubt be subject to significant revision, while Europe's problems are well documented.

The latest minutes from the Bank of England showed that policymakers remained split on whether further asset purchases are required, while a number of members remained unconvinced that inflation will quickly fall below target, especially in the second half of 2012. This could well prompt a split on whether to embark on further QE at the February meeting in two weeks' time.

The risks to the upside on inflation are set to come from rising oil prices due to rising tensions in the Middle East and also from firms looking to increase margins, especially with the Olympics and the Diamond Jubilee coming up.

It remains likely that inflation will continue its recent downward path with last year's VAT rise due to drop out in the January figures and the fall in energy prices also set to filter through in February.

Even with those falls it is by no means certain that prices will fall back below the 2% level as indicated by Mervyn King, given that even the core inflation rate still remains above the 3% level.

Judging by recent comments by Mervyn King in a speech in Brighton last week he appears to be in the Posen camp with respect to further QE, with the likelihood that further asset purchases will be on the agenda at the February meeting.

Given that an extra £75bn was added to the economy in October and the economy still slipped back, it could be argued as to the effectiveness of the delivery mechanism of the extra asset purchases. This then lends itself to ask how much more effective will any extra QE be.

Markets are entitled to ask is the Bank boosting the economy in the most effective way possible. Certainly October's additional stimulus wasn't the panacea that the Bank hoped it would be, and there's no guarantee that further QE will be any different, given that this money doesn't appear to be filtering down into the real economy, in the form of business investment.

The effect on the pound has been remarkably benign despite the speculation of further QE and there certainly hasn't been the weakness one would associate with such a policy.

This can be mainly put down to the problems in Europe and irrespective of the measures taken by the central bank we could well see further sterling gains against the euro.

The key level on EURGBP is currently around the 0.8425 area and further sterling strength seems likely towards 0.8065 while this level holds, especially if the situation in Europe continues to weigh on sentiment and the ECB continues its recent relaxed monetary policy, and its policy of QE by the back door in the form of more LTRO's in February.

Against the US dollar it is slightly different scenario and it is here we could well see sterling weakness.

The pound is currently pushing against a range of resistance levels above the 1.5610 level which if broken could well see further upside.

Certainly a close below the 1.5550 level could well signal a move back towards the January lows at 1.5240, but we would need to see a close around these levels in NY today.

Last week's dovish FOMC press conference could well play a factor in the future direction of the cable especially given the Fed pushed out its low rates policy beyond 2013, which could result in some short term US dollar weakness.

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