UK GDP Contracts Again—BoE Faces August Rate Cut Dilemma; GBP/USD Sinks

UK GDP Contracts in May: Will the BoE Cut in August?

Will May’s GDP miss push the BoE into action? Here’s what the data, experts, and markets are saying.

A weaker-than-expected GDP reading for May fueled speculation of a near-term Bank of England rate cut.

On a quarterly basis, the economy expanded by 1%, up from 0.7% in April. Yet signs of strain deepened, Annual growth slowed to 0.7% in May, down from 0.9%.. A 0.1% contraction in May on a monthly basis also suggested continued economic weakness, supporting further monetary policy easing.

According to the Office for National Statistics:

• Monthly services output grew by 0.1% in May after falling by 0.3% in April.
• Retail trade, excluding motor vehicles and motorcycles, plunged 2.7% after rising for four months in a row.
• Production output was the largest contributor to the monthly GDP fall, dropping by 0.9% in May, following a 0.6% decline in April.
• Manufacturing output slid 1% after a 0.9% fall in April, weighing on headline production output.

Overall, the monthly data revealed further cracks in the UK economy, with services and production pressuring momentum.

Experts Highlight Inflation: Sticky Inflation May Delay BoE Rate Cuts

The latest GDP figures could pressure the Bank of England to cut rates in August. However, UK inflation remains a bugbear. The UK’s annual inflation rate eased from 3.5% in April to 3.4% in May, holding well above the BoE’s 2% target. Despite services inflation cooling from 5.4% in April to 4.7% in May, elevated levels may leave the BoE in a policy holding-pattern.

In June, Research Director at the Resolution Foundation, James Smith, remarked on inflation, stating:

“The key, for those voting for no change, is that inflation may prove sticky either of weak supply, or because inflation expectations pick up (e.g. because of high food prices)… Markets continue to expect 2 more cuts this year. What could shift the dial on that? The key here is more evidence of a cooling labor market.”

Considering the current inflation levels and May’s GDP numbers, a weakening in the labor market may boost bets on a BoE policy move. The BoE kept interest rates at 4.25% in June, with six Monetary Policy Committee members voting in favor of leaving rates unchanged.

Nevertheless, concerns about services inflation could overshadow today’s data and the potential impact of a deteriorating labor market on the UK economy. The next CPI report could change the narrative, but the numbers are out until Wednesday, July 16.

GBP/USD Reaction to May’s GDP Report

Before the UK GDP Report, the GBP/USD briefly climbed to a high of $1.35848 before sliding to a low of $1.35439.

However, in response to the report, the GBP/USD tumbled from $1.35613 to a low of $1.35364, reflecting expectations of a more dovish BoE stance.

On Friday, July 11, the GBP/USD was down 0.20% to $1.35458.

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