Stagflation fears for UK economy to weigh on pound

There’s not much to like from the July monthly GDP update for the UK. The news makes grim reading: there was zero growth in the economy at the start of the third quarter, and growth in the three months to July was only 0.2%. The decline was led by production, both manufacturing and industrial production suffered heavy losses at the start of the summer, the index of services has eked out a 0.1% gain and construction managed to defy the odds and grow by 0.2%. However, if the third quarter is not going to be a disaster for the UK economy, then growth in August and September will need to do the heavy lifting.

The pound is extending losses on this news and is eroding some of Thursday’s gains. For now, GBP/USD is hanging on to $1.3550, however, if bond yields start to rise on the back of this data, then we could see pound weakness later on Friday. The pound is the third worst performer in the G10 FX space so far today.

Tariffs hit UK growth

Overall, growth in the UK economy slowed in the three months to July, and production was the weak point. The falls in production were broad based, according to the Office for National Statistics, which suggests that a mixture of tariff concerns and a higher tax burden for business is now having a material effect on the economy.

Within the service sector, the health, computer programming, and office support sectors all posted gains, however, this was not enough to boost the overall economy.

Trade blow to growth figures

The other blow to the UK was trade data, which also weighed on GDP. The underlying trade deficit widened by £0.4bn in the three months to July to £10.3bn, as imports rose by more than exports. Exports to the US remain below their pre-tariff rate, according to the ONS, which is a sign that President Trump’s policies, although ostensibly ‘fairer’ to the UK, are still wreaking havoc with the UK’s economy.

The trade in goods deficit widened in the three months to July, luckily the trade in services saw its surplus widen by £2.6bn to £51.6bn for the year, which is one bright spot in an otherwise bleak picture for the UK economy. For now, services exports are not subject to US tariffs, however, reports in recent months suggest that the service sector in the UK economy could get hit by taxes in the November budget.

Fragile UK economy as we lead up to Budget

This report suggests that the UK economy is in a fragile position as we lead up to the Budget. It is also a reminder that the Labour government does not have a grip on growth and that their relentless tax and spend policies are having a detrimental impact on the economy. Let’s hope the chancellor heeds the advice of the Barclays boss, her one time city pal, in the FT today.

This data is unlikely to give investors confidence in the UK economy, and we could see the pound extend losses later today. The bond market could also be impacted, when pubic sector debt is rising at the same time as growth is faltering and inflation is rising, this tends to be bad news for the UK economy.

BOE rate cut expectations could get a boost

The Bank of England could be the UK’s last hope, although MPC members have sounded wary of cutting rates in recent weeks due to stubbornly high levels of inflation.  There is less than 1 full rate cut priced in by the BOE for this year, however, we could see some recalibration of rate cut expectations on the back of this report, which could also undermine sterling.

Overall, the specter of stagflation continues to hang over the UK economy, which is not ideal leading up to the Budget.