The British pound weakened on Friday after official data showed an unexpected contraction in the UK economy for October, raising concerns about the possibility of faster interest rate cuts by the Bank of England (BoE) next year.
According to the Office for National Statistics, economic activity declined by 0.1% in October, defying expectations of a 0.1% rise. This marked the second consecutive monthly contraction, a first since the COVID-19 pandemic triggered the UK’s initial lockdowns in 2020.
Sterling reacted sharply to the news, falling as much as 0.43% before settling at $1.2635, a 0.3% drop on the day. Against the euro, the pound slipped 0.4% to 82.895, though it remains poised for a second consecutive monthly gain against the common currency.
Neil Jones, managing director of FX sales and trading for TJM Europe, said the contraction caught markets off guard. “This is not part of the game plan,” he remarked, noting that the data could alter expectations for the BoE’s policy trajectory. However, Jones added that the outlook for 2025 remains encouraging. He expects limited downside for the pound, as strong wage growth and persistent inflation are likely to deter the BoE from cutting rates as aggressively as the European Central Bank (ECB) or the Federal Reserve.
Economic Struggles Mount
The UK economy has faced mounting challenges in recent months. Manufacturing activity continues to deteriorate, grocery inflation is creeping higher, and job vacancies are drying up. Earlier this week, a report showed a sharp drop in demand for workers in November, which analysts attribute to higher taxes imposed in the Labour government’s first budget.
Friday’s GDP figures underscore the fragile state of the economy and increase the likelihood of a more protracted slowdown. Analysts believe the BoE may need to act decisively to counter these headwinds, potentially accelerating its pace of rate cuts in 2024.
Interest Rate Dynamics
The pound’s performance against the euro reflects diverging expectations for monetary policy. While markets anticipate the ECB will deliver up to five rate cuts by 2025, the BoE is expected to proceed more cautiously, owing to stubborn inflation and wage pressures. These factors could provide some support for sterling in the medium term, even as short-term challenges persist.
The ECB’s cautious stance was evident this week when it lowered interest rates by 25 basis points. While the move was widely expected, the central bank signaled a less aggressive approach to further easing, which could limit the euro’s appeal relative to the pound.
Market Outlook
Despite the immediate sell-off, analysts suggest the pound’s downside may be limited. Persistent inflation and robust wage growth are likely to prevent the BoE from cutting rates as aggressively as other central banks.
Still, the UK faces significant hurdles, from weak business activity to tightening household budgets, which could weigh on economic growth and limit sterling’s upside potential in the near term.
In summary, the pound’s decline on Friday reflects growing concerns about the UK economy’s resilience and the BoE’s policy outlook. As the year progresses, the interplay between inflation, wages, and monetary policy will remain a key driver for sterling’s trajectory.
