Sluggish Economic Growth Sparks Expectations for Another Interest Rate Pause
UK economy experienced a slow growth of 0.3% in the third quarter, despite a slump in July caused by heavy rainfall. As a result, the Bank of England (BoE) is anticipated to pause interest rates next month. This comes after weak economic data revealed the repercussions of previous rate hikes.
Although the 0.3% growth in the third quarter matched forecasts, underlying data has raised concerns among analysts about a forthcoming downturn. While it is expected that interest rates in the UK, US, and eurozone will remain higher for a longer period during the next economic cycle, a sudden downturn may prompt the BoE to consider interest rate cuts in the coming months.
In August, gross domestic product rebounded by 0.2% following a contraction of 0.6% in July due to adverse weather conditions and industrial action. George Lagarias, Chief Economist at Mazars, commented, “UK growth remains stubbornly above the recession line. Despite rising unemployment and high interest rates impacting disposable income, most economists anticipated a contraction which has yet to materialize.”
August’s growth was primarily driven by a 0.4% increase in the services sector, offsetting continued weakness in production and construction. In contrast, production output declined by 0.7% compared to a 1.1% dip in July, while the construction sector contracted by 0.5% in August and 0.4% in July. UBS economists Anna Titareva and Reinhard Cluse stated, “We anticipate no further rate hikes from the BoE.”
During their last meeting in September, the BoE decided to maintain its policy rate at 5.25%, ending a string of 14 consecutive rate hikes. “While the MPC’s forward guidance doesn’t exclude the possibility of additional hikes, we believe the window for further increases is now mostly closed,” mentioned Titareva and Cluse. They further stated, “Given the BoE’s emphasis on the duration of restrictive policies, the expectation of declining inflation in the coming months, and potential economic contraction, the markets currently predict a +8bp increase in November and +4.5bp increase in December, with the first rate cut (25bp) expected in November 2024.”
Mr. Lagarias added, “The economic environment remains challenging, especially with the rise in energy prices. However, the consistent growth in the UK suggests that any further slowdown, aligning with the global economy, may not lead to more than a shallow recession. If growth persists, we can also expect interest rates to remain higher for an extended period.”
In its April forecasts, the Office for Budget Responsibility projected a 0.2% GDP contraction for the UK in 2023, followed by a jump of 1.8% and 2.5% in 2024 and 2025, respectively. However, the increase in BoE base rates has caused borrowing costs to soar, affecting economic output. Paula Bejarano Carbo, Associate Economist at The National Institute of Economic and Social Research, said, “GDP increased by 0.3% in the three months ending in August compared to the previous three-month period. However, with recent high-frequency indicators pointing to declining output in major sectors and muted spending, it is uncertain whether overall growth can be expected in the third quarter.”
UK borrowers were relieved last month when the BoE decided to pause its rate-hiking cycle at 5.25% following 14 consecutive increases. However, the full impact of this cycle on the cost of borrowing is yet to be felt, and consumer price inflation remains high at 6.7%. Modupe Adegbembo, G7 Economist at AXA Investment Managers, expects the BoE to maintain the Bank Rate at 5.25% in the upcoming meeting on November 2. They further predict two 25 basis points cuts in August and November 2024, bringing the Bank Rate to 5% by the end of 2024.
When inflation remains high and the economy continues to grow, economists generally advocate for higher interest rates. The BoE’s Monetary Policy Committee will consider Thursday’s growth data in their forthcoming meeting on November 2, alongside fresh statistics on the labor market, inflation, and house prices. The BoE will also monitor developments in the US, where recent data revealed higher-than-expected inflation. Hetal Mehta, Head of Economic Research at St. James’s Place, stated, “The economy remains weak, with monthly GDP showing little change since the beginning of 2022, and the full impact of the BoE’s rate increases is yet to be realized. As credit conditions tighten and the UK labor market softens, the economy is likely to remain weak in the months ahead.” Thomas Pugh, Economist at RSM UK, added, “Overall, we anticipate the economy to continue stagnating for the next year, but there is still a significant risk of a recession. If growth turns negative, the MPC would have the opportunity to cut rates much faster than currently expected by us or the market.”
Despite ongoing growth in the economy, the output of key sectors is struggling.
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