In a twist that took economists and financial analysts by surprise, the UK’s economy experienced an unexpected contraction in the month of October. This downturn, marked by declines across various sectors, has raised concerns about the possibility of the country slipping into a recession. The decline in gross domestic product (GDP) by 0.3 percent between September and October, as reported by the Office for National Statistics (ONS), has sent shockwaves through the financial markets.
The unforeseen contraction
Economists had anticipated stability in GDP after witnessing a 0.2 percent expansion in the preceding month. However, the reality painted a different picture. The services sector, which plays a pivotal role in the UK’s economy, faced a 0.2 percent decline in October. This downturn was primarily driven by decreases in information and communication services, making it the main contributor to the overall GDP decline. Furthermore, both the production and construction sectors experienced significant drops of 0.8 percent and 0.5 percent, respectively.
This surprising economic downturn has occurred just before the Bank of England‘s decision on monetary policy, scheduled for Thursday. As expectations loom that the central bank will maintain interest rates at a 15-year high of 5.25 percent, the recent GDP contraction has added uncertainty to the equation.
Impact on currency and market sentiment
The news of the UK’s shrinking economy had an immediate impact on the financial markets. Sterling depreciated by approximately a third of a cent against the U.S. dollar and displayed weakness against the euro as well. Investors, responding to this development, increased their bets on the possibility of the Bank of England reducing interest rates in June 2024. Additionally, the yield on 10-year British government bonds plunged to its lowest level since May.
Despite these market reactions, the central bank is widely expected to hold the Bank Rate steady at 5.25 percent and continue its firm stance against rate cuts. The primary objective remains addressing the country’s persistent inflation rate, which stood at 4.6 percent in October, well above the central bank’s comfort zone.
Some experts are now contemplating the possibility of the UK entering a recession. The data for October hints at a troubling trend, although the Bank of England is likely to resist immediate rate cuts, favoring a cautious approach. The October GDP data, combined with signs of slowing wage growth, may prompt some members of the Monetary Policy Committee to reconsider their stance on rate hikes.
Elizabeth Martins, an analyst at HSBC, suggested that while the majority of the MPC is expected to vote in favor of keeping rates unchanged, the weak GDP data could sway some members who had previously supported rate hikes. The economy has been characterized by stagnation throughout 2023, with output levels mirroring those of January. The services sector shrunk by 0.2 percent in October, while manufacturing and construction experienced contractions of 1.1 percent and 0.5 percent, respectively.
The UK economy had managed to avoid contraction in the July-to-September period, but concerns persist about the possibility of a shallow recession in late 2023 and early 2024 following the Bank of England’s rate hikes.
Despite being 2.0 percent larger than its pre-pandemic levels in early 2020, the UK economy faces ongoing challenges. The services sector, a cornerstone of the nation’s economy, faces headwinds with a 0.2 percent contraction in October. Meanwhile, manufacturing and construction sectors continue to struggle with contractions of 1.1 percent and 0.5 percent, respectively.
Prime Minister Rishi Sunak and Finance Minister Jeremy Hunt have pledged to stimulate growth, but a significant uptick in economic activity is not expected until after the upcoming election, which Sunak must call before January 2025. The negative GDP data for October has put the Prime Minister’s goal of economic growth in jeopardy, with high inflation and borrowing costs likely to suppress economic activity in the final months of the year.
In addition to the economic challenges, separate data revealed that Britain posted a larger-than-expected goods trade deficit of £17 billion ($21.30 billion) in October, surpassing expectations for a £14 billion gap. Exports to the European Union, which faces its own recession risks, saw a sharp decline. Adjusted for inflation, goods exports to the EU, from which Britain recently separated, have fallen for the third consecutive month, reaching their lowest levels since mid-2009, excluding the fluctuations caused by the COVID-19 pandemic.
The unexpected contraction in October has left the UK’s economic outlook uncertain, with implications for monetary policy and the country’s growth prospects. As Britain navigates these challenges, policymakers face the daunting task of ensuring stability and recovery in an ever-changing economic landscape.