Insights on UK Economy Contraction in July Amidst Looming Mild Recession

In July, the U.K. gross domestic product experienced a decline of 0.5%, falling short of the 0.2% contraction anticipated by economists surveyed by Reuters.

The main factor dragging down the GDP was a decline of 0.5% in services output, as reported by the Office for National Statistics (ONS). Although the overall performance of the economy for the second quarter was better than expected, with a growth rate of 0.2% according to the ONS, the surprise dip in July resulted in the fastest contraction since December, according to ONS figures.

This decline is indicative of the economic strain caused by the higher interest rate environment. Additionally, data released on Tuesday revealed that U.K. mortgages in arrears reached a seven-year high in the three months leading up to June.

Following this reading, major investment banks have revised their U.K. growth forecasts. Goldman Sachs adjusted its annual growth forecast to 0.3% from 0.5%, JP Morgan downgraded its 2023 forecast to 0.4% from 0.6%, and lowered its 2024 forecast to 0.2% from 0.4%.

Despite these challenges, James Smith, a developed markets economist at ING, noted that the economy still appears to be growing, albeit marginally.

“We anticipate that the economy will remain relatively stagnant in the coming quarters, and a mild recession cannot be ruled out,” he said.

Paul Dales, chief U.K. economist at Capital Economics, suggests that the GDP figures may indicate that a mild recession has already begun and that “underlying growth has lost momentum since earlier in the year.”

Dales pointed out that strikes and unusually wet weather have had a negative impact on certain sectors. However, the decline in output indicates a more widespread weakness.

Nevertheless, Dales believes that, despite these challenges, the Bank of England will likely raise interest rates one final time next week, from 5.25% to 5.50%, given the persistently strong wage growth.

The central bank may have additional concerns as data released on Tuesday showed that annual growth in pay, excluding bonuses, remained steady at a record high of 7.8%. Simultaneously, there were signs of a slight cooling in the labor market, with a 0.5 percentage point increase in unemployment.

The British pound was 0.2% lower against the U.S. dollar at $1.245 as of 8:40 a.m. London time Wednesday. It also declined against the euro.

Jane Foley, head of FX strategy at Rabobank, highlighted the “difficult predicament” faced by the BOE given strong earnings data combined with slower U.K. growth.

She stated, “While the market assumes that a rate hike in September is a certainty, the uncertainty for future meetings is increasing. Excessive tightening could potentially lead to a U.K. recession, and this possibility seems more likely after today’s monthly GDP report.”

Moreover, Foley believes that weaker growth data raises the likelihood that Bank rate will reach its peak this month, which is putting downward pressure on the pound.