Macroeconomics of the UK

Essential insights for GBP traders...

Saturday, February 08, 2025, Week 6

The UK's constitutional monarchy and parliamentary democracy provide a generally stable backdrop for the Pound (GBP). The Head of State, King Charles III, plays a ceremonial role, while Prime Minister Keir Starmer, leader of the Labour Party, heads the government. Starmer's Labour government, securing a majority in the July 2024 general election, ended 14 years of Conservative rule. The political structure is bicameral, with the House of Commons and the House of Lords comprising Parliament. This new Labour majority should, in theory, provide a degree of policy stability.

However, the last six weeks, and potentially the next six, are dominated by significant policy adjustments and a degree of political uncertainty. Starmer's government has been proactive, enacting several policy changes with potential market implications. The October 2024 budget was a major event, featuring £40 billion in tax rises – the largest since 1993. This includes increases to National Insurance contributions, frozen income tax thresholds, and changes to farm inheritance tax. The government also announced spending cuts, including the abolition of winter fuel payments for most pensioners (except those receiving pension credit), which has proven to be a highly contentious move.

Beyond the budget, the government's early release scheme for prisoners has generated controversy. The establishment of a Border Security Command to tackle illegal immigration and a National Violent Disorder Programme to address domestic unrest reflects a focus on security.

All of these policies, taken together, create a complex picture for the GBP. The tax rises could dampen economic activity, while the spending cuts may impact specific sectors. The prisoner release scheme and social policies add an element of social and political risk. The commitment to increased defence spending signals a potential fiscal expansion, although that may be offset by tax rises and budget cuts.

Economy of the United Kingdom and the Pound: A Mixed Bag of Indicators

The UK economy, the world's sixth-largest with a nominal GDP of $3.588 trillion in 2024 and a population of approximately 67.6 million (2022 data), is heavily service-driven. Services account for a massive 82% of GDP (2023 data), with finance, business services, and creative industries being particularly important. Major UK-based companies like BP, Shell, HSBC, GlaxoSmithKline, AstraZeneca, and others in the financial and service sectors are crucial to watch, as their performance often has a direct impact on market sentiment. The primary exports include cars, power generators, pharmaceuticals, crude oil, and aerospace technology. Key trading partners include the US, Germany, Ireland, and other EU members, as well as significant trade with China.

The latest economic indicators present a mixed picture. The UK economy showed no growth (0.0%) quarter-on-quarter in Q3 2024, a downwards revision from the previous 0.1%. October GDP contracted by 0.1%, and forecasts indicated contraction.
Inflation is a persistent concern, with annual inflation rising to 2.3% in October 2024, exceeding the Bank of England's (BoE) target. Core inflation also edged up. The labour market shows signs of softening, with the unemployment rate at 4.3% (August-October 2024). Business and consumer confidence have both declined. Recent data including the S&P Global/CIPS UK Services PMI was revised down to 51.1 in December from a preliminary of 51.4.

This mix of slowing growth, rising inflation, and weakening confidence creates a challenging environment for the GBP.

Market Themes and Narratives of the United Kingdom and the Pound: Dovish Expectations and Global Risks

The dominant market theme impacting the GBP over the past six weeks, and likely to continue influencing it in the coming six weeks, is the expectation of further monetary easing from the Bank of England. The BoE cut rates by 25 basis points (bps) to 4.5% on February 6th, 2025, and the market is heavily pricing in further cuts. The split vote (7-2) at the last meeting, with two members favouring a 50 bps cut, underscores the dovish sentiment within the MPC.

This dovishness is driven by concerns about the UK's economic outlook. The combination of weak economic data, a softening labour market, and persistent (though easing) inflation is pushing the BoE towards further loosening. The MPC, while recognising a slowdown in growth, believed there was persistence in inflation that required close monitoring.

Beyond domestic factors, global risk aversion is a major headwind for the GBP. President Trump's "America First" trade policies, particularly his tariff threats against China, the EU, Mexico, and Canada, have created significant market uncertainty. This has fuelled demand for safe-haven currencies like the USD, putting downward pressure on the GBP. The tech sell-off, sparked by fears of Chinese AI competition (specifically, the emergence of DeepSeek), added to the risk-off sentiment.

The interplay between the BoE's policy decisions, UK economic data, and global risk sentiment will be the key drivers of the GBP's performance in the coming weeks.

Geopolitics of the United Kingdom and the Pound: Navigating a Volatile World

Geopolitics are significantly impacting the GBP, primarily through the lens of global risk sentiment. The UK's close relationship with the US is being tested by Trump's unpredictable trade policies. While the "Special Relationship" has been reaffirmed, the threat of tariffs and trade disputes is a major source of uncertainty.

The escalating US-China trade and technology rivalry is another critical factor. The US is tightening restrictions on AI chip exports to China, and Trump's rhetoric remains confrontational. This conflict has direct implications for global trade and is indirectly affecting the GBP through its impact on risk appetite. The war in Ukraine and tensions in the Middle East also weigh on investor sentiment.

Domestically, the Labour government's commitment to increased defence spending and a tougher stance on China introduces a new dynamic. The ongoing domestic security concerns, highlighted by the government's response to recent riots, add another layer of complexity.

In the next six weeks, the focus will remain on the US-China relationship, the ongoing conflicts in Ukraine and the Middle East, and the evolution of the UK's foreign policy under Starmer. Any escalation in these areas could trigger further risk aversion and put additional pressure on the GBP.

The Central Bank of the United Kingdom and the Pound: The Bank of England's Dovish Turn

The Bank of England (BoE), led by Governor Andrew Bailey, is the central bank of the UK. It's responsible for maintaining monetary and financial stability, and its Monetary Policy Committee (MPC) sets interest rates to achieve the government's 2% inflation target. The BoE operates independently but is accountable to Parliament. The MPC consists of nine members: the Governor, three Deputy Governors for Monetary Policy, Financial Stability and Markets, Banking and the Chief Economist, plus four external members appointed by the Chancellor.

The BoE's recent monetary policy decisions have been a major driver of the GBP's weakness. The BoE cut its key interest rate (Bank Rate) by 25 basis points to 4.5% at its February 6th, 2025 meeting. This was the third rate cut since August 2024, and the market is expecting more. The MPC's vote was 7-2 in favour of the cut, with two members preferring an even larger 50 bps reduction, highlighting the dovish sentiment within the committee. The Bank of England’s Monetary Policy Summary on 06 Feb 2025 stated that the MPC would keep close watch on the "risks of inflation persistence" and the data, before deciding on the next rate cut.

The BoE's forward guidance emphasizes a "gradual and careful approach" to withdrawing policy restraint, but the market is clearly anticipating further easing. The bank's next policy decision and statement, expected on March 20th, 2025 will be a key event for the GBP. The central bank is also continuing its quantitative tightening (QT) program, reducing its holdings of government bonds.

Market Fundamentals of the United Kingdom and the Pound: A Bearish Outlook with Significant Uncertainty

The fundamental picture for the GBP is, in my assessment, bearish, but with significant uncertainty. The BoE's dovish stance, the slowing economy, persistent inflation (though easing), and the global risk-off environment are all major headwinds. The market is pricing in further rate cuts, which will likely continue to weigh on the currency.

The UK's economic data is mixed. While some indicators, like recent employment figures, have shown resilience, others, like the fall in consumer confidence, weakening retail sales, and a contracting manufacturing PMI, point to a weakening economy. The recent GDP figures confirming stagnation increase the likelihood of a recession.

The Commitment of Traders (COT) report shows a mixed positioning in GBP futures, with dealers net short, asset managers net short, and leveraged funds moderately net long. This divergence in positioning reflects the high level of uncertainty in the market.

The upcoming six weeks will be crucial for the GBP. The BoE's March 20th policy decision, and the accompanying Monetary Policy Summary, will be a major focal point. Key economic data releases, including GDP, inflation, and employment figures, will provide further clues about the health of the UK economy. The global geopolitical landscape, particularly US-China trade relations and the ongoing conflicts, will continue to influence risk sentiment and impact the GBP.

In summary, the GBP is facing a challenging environment. While the recent recovery provides some short-term relief, the underlying fundamentals remain weak. The BoE's dovish stance, the slowing economy, and global risks all point to potential further GBP weakness. As a trader, I'll be watching the data, the BoE, and the geopolitical headlines very closely.