UK economic slowdown hits Pound as output shrinks again
The British Pound weakened following an unexpected reduction in the UK’s economic activity during May. For the second month running, the UK economy has contracted, creating fresh pressure on the Pound’s value.
Sterling fell to 1.1595 against the Euro after the Office for National Statistics revealed that GDP slipped by 0.1% compared to April’s fall of 0.3%. This reading was disappointing for analysts who had predicted a modest rebound of 0.1% growth. Against the US Dollar, the Pound eased to 1.3541.
A closer look at the figures offers little comfort to the Chancellor of the Exchequer, Rachel Reeves:
Industrial production continued its downward trajectory, registering a 0.9% monthly decline in May after April’s 0.6% fall. This result was worse than the expected flat reading. The picture was bleaker still for manufacturing, which contracted by 1.0% month-on-month, deeper than April’s 0.9% drop and far below projections for only a slight dip.
One area of resilience came from the services sector, the largest contributor to the UK economy. It managed a small expansion of 0.1%, driven by solid advances in information and communication, which rose 2.0%, and legal services, which jumped by 6.1%. However, these gains were partly offset by a 2.7% slide in retail activity.
Markets believe this set of results increases the likelihood that the Bank of England will accelerate plans to cut interest rates, a factor weighing further on the Pound’s performance. This disappointing data emerges as concerns grow over the sustainability of the UK’s public finances. Fluctuations in the debt market are indicating that borrowing levels are becoming increasingly difficult to manage.
Chancellor Reeves faces an urgent need for stronger economic growth to boost tax revenues. Without this uplift, she may have no choice but to raise taxes, a move that could worsen the slowdown already under way.
Trade tensions overshadow FX as markets search for clarity
With few significant data releases influencing foreign exchange markets this week, investors were left to focus largely on the torrent of trade tariff developments. This presented an opportunity to witness more plainly a crucial transition in what is powering recent market moves. Rather than relying purely on sentiment, traders are increasingly looking for concrete confirmation that U.S. policy risks are now the primary source of momentum.
Perhaps the most notable illustration of this unpredictability emerged when Donald Trump threatened to impose a 50% tariff on Brazilian imports. The threat appeared motivated purely by domestic political considerations related to the treatment of former President Jair Bolsonaro. This episode underscored the administration’s inclination to weigh non-economic factors when determining trade policy, despite the somewhat surprising reality that the United States currently enjoys a trade surplus with Brazil.
Even so, the dollar inched higher, while both the euro and pound extended their recent losses. As discussed in yesterday’s analysis, from both a technical and fundamental standpoint, this waning momentum has already been taking shape. So far this week, the euro and pound have each dropped by approximately 1% against the dollar.
Looking forward, any attempt to rekindle these rallies will depend on clear macroeconomic evidence that the U.S. economy is indeed being undermined by the impact of tariffs. Only such proof would be likely to revive the sentiment-driven wave of dollar selling seen earlier in the year before the summer months. At present, the uncertainty over whether these measures will be enacted no longer seems sufficient to lift the euro and pound further.
If the U.S. economy continues to show resilience and inflation remains stubbornly high, dampening expectations for near-term Federal Reserve rate reductions, a further correction lower for the euro and pound is becoming an ever more probable outcome. The release of U.S. inflation figures next week will be crucial in shaping this view.
