BoE Rate Cut: A Turning Tide for the UK Economy?
Bank of England's rate cut creates uncertainty. Labour government must balance finances and policy agenda.
Thursday, August 1, Week 31
This report provides a comprehensive analysis of the current macroeconomic landscape of the United Kingdom, offering valuable insights for forex traders. It delves into the recent shifts in fiscal and monetary policy, examines key economic indicators, and assesses the potential risks and opportunities that lie ahead.
The UK economy has shown signs of resilience in the first half of 2024, exceeding growth expectations. The Bank of England has initiated a rate cut cycle, aiming to balance inflation control with economic growth. Meanwhile, the new Labour government, having won the general election on July 4th, faces the challenge of stabilising public finances while implementing its ambitious policy agenda. The interplay of these factors creates a complex and dynamic environment for forex traders, demanding careful monitoring of key economic indicators and upcoming events.
Balancing the Books: A Fiscal Tightrope Walk
The UK government is currently grappling with a challenging fiscal situation, marked by a substantial budgetary deficit. In the 2023-24 financial year, the public sector net borrowing reached 4.4% of GDP, a figure that underscores the need for fiscal consolidation. To address this, Chancellor Rachel Reeves announced a series of spending cuts on July 29th, aiming to plug a £22 billion budgetary hole inherited from the previous Conservative government. These cuts, coupled with some public sector pay raises, signal a move towards fiscal tightening, although the full extent of the government's plans will be revealed in the autumn budget.
The government's debt level is a key concern, with potential implications for currency valuation and inflation. High levels of government debt can erode investor confidence in the currency, leading to depreciation. Additionally, the need to finance this debt can contribute to inflationary pressures. The Labour Party's manifesto includes pledges for significant spending increases in areas such as public services and the energy transition, potentially creating friction with the need for fiscal consolidation. Forex traders should closely monitor the government's actions to balance these competing priorities, as they could significantly impact the value of the pound.
UK Economic Landscape: A Mixed Picture
The UK economy has demonstrated resilience in the first half of 2024, exceeding growth expectations. GDP expanded by 0.7% in Q1, a significant upward revision from the initial estimate of 0.6%. This growth was driven by a robust performance in the services sector, which expanded by 0.8%, and a 0.6% increase in production. However, the construction sector contracted by 0.6%, reflecting ongoing challenges in the housing market.
Key economic indicators present a mixed picture. The unemployment rate rose to 4.4% in the three months to May 2024, reaching its highest level since September 2021. This rise in unemployment, coupled with a decline in the vacancies-to-unemployment ratio, suggests a loosening labour market. However, wage growth remains elevated, with average weekly earnings including bonuses increasing by 5.7% year-on-year in the three months to May 2024. Inflation has fallen back to the Bank of England's 2% target, driven by lower goods price inflation, but services price inflation remains elevated at 5.7% in June.
Looking ahead, economic forecasts suggest a possible slowdown in GDP growth in the second half of 2024. This potential slowdown is attributed to the lagged impact of the Bank of England's interest rate hikes, as well as the government's fiscal tightening measures. The housing market is expected to remain subdued, with house prices projected to be flat or to rise only slightly.
The UK's economic performance compares unfavourably to that of its major trading partners, particularly the United States and the Eurozone. The US economy continues to expand at a robust pace, while the Eurozone has shown signs of recovery. This divergence in economic performance could lead to a widening trade deficit for the UK, putting downward pressure on the pound.
Charting a New Course: The BoE's Balancing Act
The Bank of England is currently navigating a complex monetary policy landscape, aiming to balance the need to control inflation with the imperative to support economic growth. The Bank's mandate is to maintain price stability, defined as a 2% inflation target. After a series of interest rate hikes that brought Bank Rate to 5.25%, the Bank opted for a 25 bps rate cut in its August meeting, bringing the rate to 5%.
This decision reflects the Bank's assessment that the risks from inflation persistence are receding. Inflation has fallen back to the 2% target, and indicators of short-term inflation expectations have moderated. However, the Bank remains cautious, acknowledging the potential for inflationary pressures to prove more enduring in the medium term. The decision to cut rates was a close call, with four members of the Monetary Policy Committee voting to maintain the Bank Rate at 5.25%.
Market expectations regarding future monetary policy actions are mixed. While a majority of investors anticipated the August rate cut, there is uncertainty about the pace and extent of future reductions. Some analysts anticipate further rate cuts in the coming months, while others believe that the Bank will maintain a wait-and-see approach, closely monitoring economic data before making further adjustments to monetary policy. The Bank's communication and actions in the coming months will be crucial for forex traders, as they will provide insights into the Bank's assessment of the UK economy and its outlook for inflation.
UK Macroeconomic Outlook: Navigating Uncertainty
The macroeconomic outlook for the UK is characterised by a mix of resilience and uncertainty. The economy has performed better than expected in the first half of 2024, but the Bank of England has initiated a rate cut cycle, and the pace and extent of future reductions remain unclear. The new Labour government faces the challenge of stabilising public finances while implementing its ambitious policy agenda.
Top Three Risks to the Outlook:
Persistent Inflation: Despite the recent fall in headline inflation, there is a risk that underlying inflationary pressures, particularly in the services sector, will prove more enduring. Key developments:
Services CPI inflation remained elevated at 5.7% in June 2024.
Wage growth remains above pre-pandemic levels.
The Bank of England's agents report that pay settlements will average just over 5.5% this year.
Fiscal Slippage: The government's ambitious spending plans, coupled with the challenge of reducing the budget deficit, create a risk of fiscal slippage. This could lead to higher interest rates, a weaker pound, and increased inflationary pressures. Key developments:
The government announced a £22 billion budgetary hole in July 2024.
The Labour Party's manifesto includes pledges for significant spending increases.
Hard Landing: The Bank of England's interest rate hikes, coupled with the government's fiscal tightening measures, could lead to a "hard landing" for the economy, characterised by a sharp slowdown in growth and a rise in unemployment. Key developments:
The Bank of England initiated a rate cut cycle in August 2024.
The government announced spending cuts in July 2024.
Action Points for Forex Traders:
Closely monitor key economic indicators, including GDP growth, inflation, unemployment, and wage growth.
Pay attention to the Bank of England's communications and policy decisions, as well as market expectations regarding future monetary policy actions.
Stay informed about the government's fiscal policy plans.
Monitor global economic trends, particularly developments in the US, the Eurozone, and China, as these could have significant spillover effects on the UK economy.
Key Economic Events to Monitor:
August 13, Week 33: Unemployment Rate JUN, Average Earnings incl. Bonus (3Mo/Yr) JUN, Employment Change JUN
August 14, Week 33: Inflation Rate YoY JUL, Core Inflation Rate YoY JUL, Inflation Rate MoM JUL
August 15, Week 33: GDP Growth Rate QoQ Prel Q2, GDP Growth Rate YoY Prel Q2, GDP MoM JUN, Business Investment QoQ Prel Q2, GDP 3-Month Avg JUN, Goods Trade Balance JUN, Goods Trade Balance Non-EU JUN, Industrial Production MoM JUN, Manufacturing Production MoM JUN
August 16, Week 33: Retail Sales MoM JUL, Retail Sales ex Fuel MoM JUL, Retail Sales YoY JUL
Economic Indicators: Gauging the Pulse of the UK Economy
Economic Growth:
GDP Growth Rate: The UK economy expanded by 0.7% in Q1 2024, exceeding expectations. The outlook for GDP growth in Q2 and beyond remains uncertain, with the potential for a slowdown in the second half of the year.
Industrial Production: Industrial production grew by 0.2% month-over-month in May 2024, rebounding from a 0.9% fall in April. The outlook for industrial production remains uncertain, with potential headwinds from weaker global demand and ongoing supply chain disruptions.
Price Changes (Inflation):
Inflation Rate: Inflation remained steady at 2% in June 2024, aligning with the Bank of England's target. However, services price inflation remains elevated at 5.7%, suggesting persistent inflationary pressures. The trajectory of inflation in the coming months will be a key factor for the Bank of England's monetary policy decisions.
Core Inflation Rate: The core inflation rate, which excludes volatile items such as energy and food, stood at 3.5% in June 2024, indicating underlying inflationary pressures.
Labour:
Unemployment Rate: The unemployment rate rose to 4.4% in the three months to May 2024, reaching its highest level since September 2021. The unemployment rate is expected to rise further in the coming months, reflecting the lagged impact of the Bank of England's interest rate hikes.
Average Weekly Earnings Growth: Average weekly earnings including bonuses increased by 5.7% year-on-year in the three months to May 2024, indicating continued strength in wage growth. However, wage growth is expected to moderate in the coming months as inflation falls and the labor market loosens.
Housing:
Nationwide Housing Prices: The Nationwide House Price Index rose by 2.1% year-on-year in July 2024, marking the sixth consecutive period of rising house prices. However, affordability constraints and higher interest rates are expected to keep the housing market subdued in the coming months.
Mortgage Approvals: Net mortgage approvals for house purchases eased slightly to 59.98 thousand in June 2024, suggesting a modest slowdown in housing market activity.
Business Confidence:
Manufacturing PMI: The S&P Global UK Manufacturing PMI was revised higher to 52.1 in July 2024, indicating a sharp expansion in the manufacturing sector. However, the outlook for manufacturing remains uncertain, with potential headwinds from weaker global demand and ongoing supply chain disruptions.
CBI Business Optimism Index: The CBI Business Optimism Index fell to -9 in July 2024, after rising to 9 in April for the first time in nearly three years, suggesting a cooling in business sentiment.
Consumer Sentiment:
GfK Consumer Confidence: The GfK Consumer Confidence indicator rose to -13 in July 2024, improving for the fourth consecutive month to its highest level since September 2021. However, the index remains below its long-term average, suggesting that consumer sentiment is still fragile.
Trade:
Goods Trade Balance: The UK's trade deficit in goods narrowed to £17.9 billion in May 2024, from a revised £19.4 billion in the prior month. The outlook for the trade balance remains uncertain, with potential headwinds from weaker global demand and the ongoing conflict in Ukraine.
Sources
Bank of England
Office for National Statistics
Trading Economics
S&P Global
Confederation of British Industry
GfK Group
BRC - British Retail Consortium
Nationwide Building Society
Halifax and Bank of Scotland
Low Pay Commission