Thursday’s UK GDP report could play a major role in shaping the pound’s direction. Domestic political uncertainty already weighs on the currency. The renewed conflict between the US and Iran has also revived inflation concerns. As a result, traders now see a greater chance of a Bank of England rate hike. Even so, economic growth will likely determine how the pound reacts, making this week’s GDP data especially important.
The US dollar strengthened over the past week, while the pound held its ground. As a result, GBP/USD has traded mostly sideways. Markets now expect a higher chance of another Fed rate hike, which has boosted demand for the dollar. At the same time, expectations for a BOE rate hike have supported the pound.
Growth Warning Signs
Higher interest rates usually slow economic activity. If GDP remains positive, investors could welcome higher rates because they would reflect a resilient economy. However, if the UK economy contracts in the second quarter, higher borrowing costs could put additional pressure on growth and weigh on the pound.
The Office for Budget Responsibility recently warned that UK debt has reached unsustainable levels. The government has three main options. It can reduce spending, raise taxes, or support stronger economic growth. Only stronger growth would likely benefit the pound.
Andy Burnham continues to gain support as the next potential Prime Minister. Investors worry that a new government could choose higher spending or taxes instead of promoting growth. Strong GDP figures would improve confidence that the government can maintain its current fiscal rules and reassure financial markets.
Reeves Focuses on Growth
Chancellor Rachel Reeves focused on economic growth during her third Mansion House speech on Tuesday. Governments often use this event to announce fiscal measures and reassure investors about public finances. However, reports suggest Reeves could soon leave her position. Her speech therefore focused on defending her record and supporting the current fiscal framework.
Many investors believe former Labour leader Ed Miliband could replace Reeves. Markets expect him to support higher public spending and taxes. That approach could unsettle investors, push long-term bond yields higher, and weaken the pound. Some traders have even compared the risks with the market reaction to Liz Truss’s Mini Budget.
What Markets Are Watching
Economists expect UK GDP to grow by 0.1% in May after a 0.1% decline in April. They also expect the rolling three-month growth rate to slow to 0.5% from 0.7%. A smaller trade deficit, forecast to narrow to £23.6 billion from £26.1 billion, could help support monthly growth. Market volatility linked to the Middle East conflict hurt economic activity in April. Investors now hope the economy recovered in May and built momentum for the second quarter.
Stronger-than-expected GDP could lift the pound. Faster growth would give the government more room to implement its policies. Weaker data could pressure the pound because it would suggest the economy still struggles with higher energy costs. Renewed fighting in the Middle East could make that outlook even more challenging during the coming quarter.
