After a couple of weeks of political turmoil in the UK, traders can now turn to some hard data. Friday’s release of the monthly GDP could be a crucial piece for figuring out where cable will be headed in the medium term. All eyes are on the Autumn budget set to be released at the end of November. However, how well the British economy performs until then could determine the actions the government needs to take to shore up its finances.
The crucial element for the markets is whether Chancellor Rachel Reeves can scrape together enough revenue to meet increasing demands for government spending. If not, she might be forced to go back on her pledge not to raise taxes. Or have to step down to avoid breaking her promise. Both scenarios would likely have a significantly negative impact on the markets, with the pound likely to weaken. Leading up to the announcement of the Budget, the chances of Reeves meeting spending goals could have a significant effect on the GBPUSD.
Britain’s Surprising Resilience
In the past, economists have been repeatedly predicting a slowdown in UK economic activity, only to be proven wrong by the data. Both Q1 and Q2 GDP figures exceeded expectations, implying increased tax collection by His Majesty’s Government and helping to shore up finances.
Once again, economists are predicting the UK economy will slow down, and be making the same mistake as before. The dour outlook for Britain’s public finances is based on an expectation that the economy will struggle through the latter half of the year. If it manages to eke out growth despite projections, then it just might be enough to allow Reeves to present a budget that meets the approval of markets.
Why the Negative Projections?
Generally, high interest rates and high taxes slow down the economy. This is the basis for many economic projections for the UK to underperform. That is, on top of the lingering effects of Brexit, which many economists say have put the British economy at a disadvantage compared to the rest of Europe. Additionally, unlike on the Continent, the government isn’t planning to increase fiscal stimulus and spending to the same degree, given budgetary constraints.
The primary reason for UK GDP data to exceed expectations is something that has been a thorn in the side of the ECB: High wages and resilient consumer spending. Retail sales have consistently beaten forecasts, raising GDP numbers. Wages in the UK have been well above (high) inflation rates, meaning a rise in real disposable income. A tight labour market that allows employees to seek better wages is seen as the primary reason for the higher wages and, therefore, a better-performing economy. Continued loosening in the UK job market might mean that the beats in the GDP figures could start dissipating.
What to Look Out For
UK July GDP is expected to drop to 0.0% from 0.4% prior. That would bring the rolling three-month average to 0.2%. Industrial production is also anticipated to flatline at 0%, compared to 0.7% growth in June.
A beat in forecasts would likely provide relief to Britain’s finances and support the pound. But if the economy shows signs of weakness, then the pound could be rattled. Markets would likely get more nervous about the Budget, raising gilts and increasing capital outflows from the country.