UK GDP Preview: Stagnation may be good enough for pound bulls, three GBP/USD scenarios

• Economists expect the UK to report stagnation in the fourth quarter of 2019.
• After several days under pressure, sterling may recover, especially if the economy ticks up.
• Outright recession risk may push the pound lower.

Standing in the same place usually means eventually falling behind – but that may not be the case for the pound in response to zero growth. There are two reasons why sterling may shine while Gross Domestic Product stagnate, as economists expect for last year's final quarter.

Things have changed since Q4 2019

The autumn of 2019 was a time of turbulence and high uncertainty. In early October, fear of a no-deal Brexit was real as the EU and the UK were apart on critical topics such as the Irish backstop. After Prime Minister Boris Johnson struck an agreement with Brussels, he still had a hard time in parliament, and the country went to the polls.

A clearer path on Brexit emerged only towards the end of the quarter – after the elections in mid-December. This uncertainty took its toll on the economy as businesses deferred decisions. Post-elections Purchasing Managers' Indexes from January already showed a return to confidence. Investors may, therefore, see the GDP figures as stale – even though they represent actual figures rather than the only sentiment. 

GBP/USD has already fallen

Brexit is far from over – while the UK officially left on January 31, it retains most rights and obligations during the transition period, which expires at year-end. Talks about future relations with the EU begin only in March, but the battle lines have been drawn, and they mark stark differences in the approach of both sides.

If the UK leaves without a deal, it will default to World Trade Organization rules, which means barriers to commerce. Moreover, reports from Brussels suggest that the EU may try to curb London's financial services sector – and hurting the crown jewel of the economy is also worrying. 

The pound has already responded to these fears – GBP/USD has dropped to the lowest since November. A figure that does not scream "recession" may be sufficient to trigger a recovery in sterling.

All in all, the wind may blow in favor of cable bulls. 

Here are three scenarios

1) Stagnation – GBP/USD advances

As explained earlier, the mix of a figure from the turbulent past – even if it is from the recent past – and somewhat oversold conditions may trigger a recovery. While gains could be limited, the outlook is positive.

This scenario has a high probability. Since the UK began publishing monthly GDP figures, economists' expectations have become more precise. 

Surprises are uncommon and limited:

2) Contraction – GBP/USD edges lower

The economy squeezed by 0.3% in November, and retail sales figures for December were depressing. If these add up to an economic squeeze, the pound may suffer. It takes two consecutive quarters of contraction to define a recession, and fears of an outright downturn may weigh on sterling.

However, it is essential to note that a decline of 0.1% would not be devastating. It would probably take a drop of 0.2% or more in output to send the pound plummeting. 

The probability is medium due to the weak data from November. 

3) Growth – GBP/USD shoots higher

With expectations standing at 0%, a minimal beat would be sufficient to extend the UK economy's growth and diminish fears of a recession.

The probability is low, and such an outcome – even a meager 0.1% expansion – would trigger a jump in the pound. 

Conclusion

UK quarterly GDP provides an in-depth look at a time when things looked much worse. The higher level of uncertainty and recent pound pressure may result in a bounce if low expectations for zero growth are met. A drop in the economy's output could weigh on the pound while surprising growth could trigger a rally.