UK Gross Domestic Product expected to shrink in Q3 as effect from higher interest rates feeds through

• The United Kingdom's Gross Domestic Product is foreseen posting a modest contraction in Q3.
• The Bank of England downgraded its forecast for economic growth in the November meeting.
• GBP/USD needs to recapture the 1.2400 mark and run past the 1.2427 peak to gain substantial upward momentum. 

The United Kingdom (UK) will release the Q3 Gross Domestic Product (GDP) preliminary estimate on Friday. Ahead of the announcement, the Pound Sterling is under selling pressure against its American rival, with GBP/USD trading at around the 1.2300 level after peaking this month at 1.2427.

Market participants are trying to assess central bank announcements, as most banks have paused monetary tightening. The return from the Coronavirus pandemic had the unexpected effect of sending inflation to multi-decade highs globally, catching policymakers off-guard. As a result, central banks engaged in an aggressive monetary tightening in early 2022, which proved effective in taming price pressures well into 2023. However, inflationary levels remain above central banks’ targets, with worldwide policymakers reaffirming the battle against inflation is not over.

Yet, as Issac Newton said, every action has a reaction. Monetary tightening put pressure on economic growth, and fears of a global recession had been the main theme for over a year. 

The United States (US) Federal Reserve and the Bank of England (BoE) have refrained from hiking rates in their last two meetings, as the risks to growth from super-high rates are far more concerning than inflation itself. The Fed benchmark rate currently stands at 5.25%-5.50%, while the BoE lifted the Bank Rate to 5.25%.

UK Gross Domestic Product forecast: What numbers could tell us

The Office for National Statistics (ONS) reported that the UK economy grew 0.2% QoQ in the previous quarter, compared with the 0.3% advance posted in the first quarter of the year. In the three months to June, the economy expanded 0.6% on year, improving from the previous 0.5%. 

In its latest meeting, the Bank of England downgraded its forecast for economic growth. The BoE now expects GDP to grow just 0.1% in the last quarter of the year, while policymakers expect inflation to return to its 2% target by the end of 2025.

Meanwhile, the UK Consumer Price Index (CPI) remains among the highest within major economies. According to the latest ONS report, the CPI increased 6.7% YoY in September, the same rate as in August, while core inflation was marginally lower to 6.1% YoY from 6.2% in August. 

Lacklustre growth in a high-inflation, restrictive-rates scenario should be no surprise. At this point, nobody doubts there will be a setback, with speculation rotating around whether major economies will face soft landings or steep economic downturns. The odds for a UK economic downturn are at 60% by the end of 2024, according to the National Institute of Economic and Social Research (NIESR).

When will the UK release Q3 GDP, and how could it affect GBP/USD?

The UK will release the Q3 Gross Domestic Product (GDP) preliminary estimate on Friday, November 10, at 7:00 GMT. The economy is expected to have shrunk 0.1% in the three months to September, while the annual comparison is foreseen at 0.5%, slightly below the 0.6% posted in the second quarter of the year. On a monthly basis, the GDP is foreseen at -0.1% in September, declining from 0.2% in August.

An outcome aligned with the market’s expectations should reaffirm the BoE’s decision to stay put. Tepid growth, and even more a slight economic contraction, somehow grants caution among policymakers, now pledging to keep rates higher for longer. 

Nevertheless, financial markets anticipate roughly 75 basis points (bps) rate cuts by mid-2024, despite BoE Governor Andrew Bailey repeating on Wednesday that officials need to keep fighting inflation and that monetary policy will need to be restrictive for an extended period. His words followed comments from Chief Economist Huw Pill, who said that a rate cut by 2024 “doesn't seem totally unreasonable,” lifting the odds for a cut from 30 bps to the aforementioned 75 bps.

Sterling Pound buyers will likely welcome an upbeat surprise, although the chances of such a scenario are limited. Should the outcome miss expectations, GBP/USD would fall, particularly considering the US Dollar is somehow stronger ahead of the event.

Valeria Bednarik, Chief Analyst at FXStreet, says: “After bottoming at 1.2037 in October, GBP/USD is looking to turn north, although US Dollar bulls are fighting back. The pair has a long way to go before turning north, as the wider perspective keeps the risk skewed to the downside. A bearish 100 Simple Moving Average (SMA) in the weekly chart provided dynamic resistance on the run past 1.2400, rejecting the pair. Furthermore, technical indicators in the mentioned time frame have lost their positive momentum within negative levels and are slowly resuming their slides.”

Bednarik adds: “The weekly low at 1.2241 offers immediate support, followed by the 1.2180 price zone. GBP/USD bulls will get discouraged if the pair slides below the latter, resulting in a firmer decline towards the aforementioned October low. The pair needs to recapture the 1.2400 threshold, and extend gains beyond the 1.2427 peak to increase the odds of a bullish continuation, with buyers then aiming to test the 1.2500 mark.”