UK economy loses momentum, BoE faces tough rate-cut dilemma; GBP/USD Dips

UK Economy Stalls in July: Are Rate Cuts Back on the Table?

Will July’s GDP force the BoE to signal rate cuts? Here’s what the data, experts, and markets are saying.

Markets eye BoE cuts after July’s GDP miss, but sticky inflation may delay action.

The UK economy stalled in July after expanding 0.4% month-on-month in June. Notably, the UK economy lost steam through the three months to July, growing 0.2% compared with 0.3% in the three months to June.

According to the Office for National Statistics:

• Monthly services output grew by 0.1% in July after rising by 0.3% in June.
• Production output was the largest contributor to the monthly GDP fall, dropping by 0.9% in July, following a 0.7% increase in June.
• Manufacturing output slid 1.3% after a 0.9% rise in June, weighing on headline production output.

The data highlighted cracks across manufacturing and slower service sector growth, raising questions about the economy’s resilience.

BoE Faces a Balancing Act: Weak Growth vs Sticky Inflation

The latest GDP figures may fuel speculation about a fourth-quarter Bank of England rate cut. However, recent inflation figures continue to drive monetary policy uncertainty. Last week, BoE Governor Andrew Bailey dampened expectations of further rate cuts, stating:

“There is now considerably more doubt about exactly when and how quickly we can move those further steps.”

The UK annual inflation rate increased from 3.6% in June to 3.8% in July, with core inflation also trending higher. Notably, services sector inflation accelerated to 5% in July, up from 4.7% in June.

The combination of rising headline and underlying inflation and steady unemployment at 4.7% has complicated the BoE’s policy stance.

Despite today’s GDP data, the BoE would likely need to see inflation soften sharply and wage growth to soften furhther to give the BoE doves a stronger case to cut rates.

Against this backdrop, ING Economics noted:

“Inflation needs to show further progress, and on headline CPI at least, that is unlikely before November… But the news isn’t all bad. The Bank ultimately cares most about service sector inflation, and we think there is scope for this to modestly undershoot the BoE’s forecasts before November. Rapidly slowing rental growth is a key driver.”

On the labor market, ING Economics suggested that slower wage growth could potentially adjust the BoE’s rate path.

Elevated inflation and interest rates, and softer wage growth could materially impact disposable income and the economy.

Will next week’s inflation and labor market data confirm the need for action? UK inflation and labor market data are due out on September 15 and September 17, respectively.

A sharp drop in inflation and wages could potentially green light a November BoE rate cut. Rising expectations of a November rate cut would likely weigh on the GBP/USD, exposing sub-$1.35.

GBP/USD Reaction to July’s GDP Report

Ahead of the UK GDP report, the GBP/USD briefly climbed to a high of $1.35804 before falling to a low of $1.35521.

However, in response to the report, the GBP/USD tumbled from $1.35580 to a low of $1.35496, reflecting sentiment toward the economic slowdown.

On Friday, September 12, the GBP/USD was down 0.15% to $1.35507. The BoE’s complicated policy outlook contrasts with the US Federal Reserve, widely expected to cut rates next week.

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