The pound fell on Thursday to its lowest levels in 2021 against the US dollar, after the release of the GDP report which showed the UK economy grew slower than expected in the last quarter.

The pound had already fallen last week when the Bank of England didn’t raise interest rates, and fell again on Wednesday when higher US inflation pushed the dollar higher.

The longer-term UK economic outlook is creating concerns, after the NIESR thinktank warned earlier this week that Britain’s economy could potentially experience a long period of stagnation that will hurt household incomes and plans to level up the regions.

Chancellor of the Exchequer, Rishi Sunak, has warned about the challenges ahead as the economic recovery from the pandemic continues: “As the world reopens we know that there are still challenges to overcome. That’s why at the Budget last month I set out our plan to build a stronger economy for the British people. We’re continuing to support businesses, jobs and people so that we can achieve our vision of a high-skill, high-productivity economy where work is rewarded.”

Economic growth slowed to 1.3% in Q3

The UK economic recovery slowed in the third quarter of 2021. UK GDP rose by 1.3% between July and September, according to the Office for National Statistics. This is below the 1.5% expected by economists. Following the third lockdown, Britain’s recovery slowed due to the rising number of infection cases, the pingdemic and global supply issues.

In the third-quarter, as restrictions were being lifted, the economy expanded 5.5% in the three months to June.

Services recorded the fastest growth, with a 30% jump in business for hotels and restaurants which helped the GDP to rise by 1.6% over the quarter. On the other hand, manufacturing and construction weakened.

UK economy grew 0.6% in September

The UK economy did grow in September, which was better than expected. July GDP growth was revised to 0.2% , while August’s estimated growth went from 0.4% to 0.2%. This means the UK economy is 0.6% smaller than in February 2020.

Paul Dales of Capital Economics said that the rise in GDP in September shows that the UK economy gained some, but this will “fizzle out over the coming months.” He clarified that progress will slow the next 6-9 months as shortages persist and businesses and households’ spending power wanes due to higher taxes and increased utility prices. He added that if the Bank of England decides to raise interest rates, this won’t be above 0.5% during 2022.

The slowdown in third quarter growth follows the disappointing news from that Bank of England that interest rates won’t be raised any time soon, despite rising inflation. The Bank wants to wait and see how the economy will respond following the end of the furlough scheme in September, as well as other persistent issues such as the supply chain crisis.

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Fears that Britain will leave the European Union without any trade agreement sent the pound to new 5-1/2-month lows on Friday, despite the UK economic recovery and a new trade deal with Japan. Businesses are as worried as ever as Boris Johnson’s government continues to defy calls from the EU to be more flexible and meet its demands. With Johnson’s latest controversial bill, businesses that export and import goods from/to Ireland are in a precarious position.

Theresa May, the former prime minister, asked: “How can the government reassure future international partners that the UK can be trusted to abide by the legal obligations of the agreements it signs?”

Worst week for the pound

Reuters reported that this is the worst week for the pound both against the euro and the dollar since mid-March. The fall was the result of reports that “Brussels has stepped up planning for a ‘no-deal’ Brexit after Prime Minister Boris Johnson’s government refused to revoke an ultimatum on breaking the divorce treaty which Brussels says will sink four years of Brexit talks.”

Klaus Baader, global chief economist at Societe Generale said: “The probability between a deal and no-deal are definitely shifting towards a no deal -- that is very clear. The risk of a no-deal is increasing every day.” Morgan Stanley also said that the risk of Britain exiting on “WTO terms” had risen to 40% compared to 25% earlier.

UK Rejects EU’s Demands, as Brexit Uncertainty Increases

The EU has warned the UK that the controversial elements of the Internal Market Bill are illegal and that it will need to remove them by the end of the month. Tories have also criticised Boris Johnson’s proposed Internal Market Bill, which will be debated on Monday by MPs in the House of Commons.

The new bill puts into question the Northern Ireland protocol, which is part of the Brexit withdrawal agreement approved in January. The protocol ensures that the province will come under the European Union’s single-market rules in order to avoid a hard border in Ireland. However, the new law would give UK ministers the right to change rules regarding the movement of goods if the UK and EU are unable to reach a trade deal. A government spokesman said that the bill will "ensure the government can always deliver on its commitments to the people of Northern Ireland". The bill tries to bypass the formal discussions and bend the rules to deliver Brexit at all costs.

The EU said that these new changes needed to be removed as they jeopardise the UK-EU trade talks. But the government has defied the EU saying that the PM’s proposed bill seeks to protect the “integrity of the UK and the peace process in Northern Ireland.”

On Monday, informal talks between the two sides will resume as differences remain and Brexit appears as uncertain as ever. With the UK government referring to the EU’s lack of realism, one would perhaps question whether discussions will reach any agreement or things would soon diverge even further.

The next official round of talks will begin on 28 September.

Positive News Fails to Lift the Pound

News that the UK has struck its first major “historic” post-Brexit trade deal with Japan has done little to offer substantial support to the pound. The deal will boost trade by about £15bn and International Trade Secretary Liz Truss said that it would bring "new wins" for British businesses in manufacturing, food and drink, and tech industries. However, critics said that the deal will only slightly boost the UK GDP by only 0.07%, which is not comparable to the trades that will be lost by leaving the EU. Britain said that 99% of its exports to Japan would be tariff-free.

But neither this news helped support the pound, neither the fact that the Office for National Statistics reported that UK economic output grew by 6.6% in July as pubs, restaurants and other sectors reopened.

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The pound has dropped to its lowest level since 27 December, after the ONS released its latest GDP estimate for the month of November.

ONS numbers

According to the ONS, the UK GDP grew by 0.1% in the three months to November, while it shrank by 0.3% in November 2019. The contraction in November was worse than expected as uncertainty over the general election and the threat of crashing out of the EU without a deal in October weighed on the economy.

As the ONS figures demonstrate, the services and production sectors grew by 0.1% and 1.1%, respectively in the three months to November 2019, but the production sector fell by 0.6%, its second consecutive rolling three-month decline, while manufacturing output fell by 1.7%.

The ONS stated: “Production fell by 1.2% in the month of November 2019, following growth of 0.4% in October. Within production, manufacturing fell by 1.7%. This was largely driven by large falls in the manufacture of transport equipment, food, and chemicals. These industries were also the main drags on growth in April 2019, just after the UK's original planned date to exit the European Union as shown in Figure 5. This may be indicative of some changes in the timing of activity around the second planned departure in October.”

Today’s figures confirm that the UK economy has slowed for two consecutive months, shrinking in April-June, then showing 0.4% growth in July-September, something which has helped to avoid a recession. It has slowed again to 0.2% in August-October, and 0.1% in September-November.

The Office for National Statistics’ head of GDP, Rob Kent-Smith, said that UK growth was at its lowest level since 2012: “Overall, the economy grew slightly in the latest three months, with growth in construction pulled back by weakening services and another lacklustre performance from manufacturing. The UK economy grew slightly more strongly in September and October than was previously estimated, with later data painting a healthier picture. Long term, the economy continues to slow, with growth in the economy compared with the same time last year at its lowest since the spring of 2012.”

UK economy stagnant

The National Institute of Economic and Social Research (NIESR) noted that the “latest data confirm that UK economic growth had petered out at the end of last year. GDP was virtually flat in the 3m to Nov & latest surveys point to further stagnation in Dec. The short-term economic outlook is for more lacklustre growth.”

More importantly, the idea of the Bank of England having to cut interest rates has resurfaced as investment strategists and traders have mentioned.

Bank of England: Interest rate cut?

The latest GDP data has boosted the chances of UK interest rates being cut soon, possibly at the Bank of England’s meeting at the end of January. Matthew Cady, investment strategist at Brooks Macdonald, said: “UK GDP for November has come in at negative -0.3%. This is quite a bit weaker than had been expected. Consensus had been looking for zero growth month on month. Against this, both September and October were revised up by 0.2% and 0.1% points respectively. The weaker GDP print today puts beyond doubt that the next Bank of England meeting at the end of January is going to be a ‘live’ meeting.”

Peter Dixon, economist at Commerzbank, said that the possibility of an interest rate cut has risen to 50%: “With a growing chorus on the MPC apparently open to the prospect of a rate cut, if the data points in that direction, today’s release might well tip the balance of one or two members ahead of the meeting on 30 January, where the market probability assigned to a 25 bps cut has risen to 50% versus 5% at the start of last week.”

However, it is also wise to be positive and consider the GDP numbers as indicative of a specific time period rather than of a future trend, as business confidence can return after Boris Johnson’s election. As chief economist at PwC, John Hawksworth, clarified, today’s data relates to a specific “period of heightened economic and political uncertainty” and that “our latest survey of the financial services sector with the CBI does suggest some boost to optimism since the election.”

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The release of the UK's GDP with a better-than-expected 0.3% growth in July, has raised chances of the UK avoiding a recession and boosted the pound. Data from the Office for National Statistics showed that all sectors of the economy grew in the month – the first of the third quarter, with manufacturing also expanding by 0.3%, and the industrial sector growing by 0.1% during the month. However, the last three months the GDP has remained flat, as Brexit uncertainty has impacted on investment.

This is why, despite Brexit recession fears having eased, the economy remains under pressure. For example, the services sector growth might be an indication that businesses are stockpiling in preparation for Brexit as its outcome continues to be unknown. Plus, as many economists indicate, it is unclear for how long growth will continue.

KPMG report  

As accountancy firm KPMG forecasted, there is a possibility of Britain falling into a recession in 2020 if it leaves the EU without a deal. According to the firm, a no-deal Brexit will negatively affect the UK’s trade and business confidence and lead to the economy shrinking by 1.5% in 2020. The accountancy giant is not the first to warn of the negative effects of Brexit on the economy, as experts have already underlined the grim economic outlook for Britain.

Forecasts by the Bank of England and the Office for Budget Responsibility, have also highlighted the negative economic consequences of a no-deal Brexit and, consequently, of losing access to the EU single market and customs union.

The possible recession will cause a rise in unemployment, a decline in consumer spending and an estimated 6 percent slide in house prices, the KPMG report added.

Yael Selfin, the  KPMG’s chief economist noted that in the case of a recession resulting from a no-deal Brexit, the decline in the pound’s exchange rate will “push up inflation to above the Bank of England’s 2 per cent target, potentially forcing the central bank to lower its key interest rate to near zero.”  With the central bank’s key rate currently standing at 0.75 per cent, interest rate cuts will possibly be no higher than 1 percentage point.

The report also said: “[The new government’s] resolve to leave the EU by 31 October has become increasingly clear . . . and the proximity of the date make the outlook for the next two years rather bipolar.” KPMG added that the pound’s 10 percent expected decline in value, will hurt even exporters as issues over borders will eliminate any positive effect the weaker currency might have. Selfin said: “The most damaging impacts could come from potential shortages of imported foodstuffs as well as medicines in the immediate term, negatively impacting households’ sentiment.”

Selfin could not be clearer when discussing the damaging effects of a no-deal on the economy: “With the Brexit debate poised on a knife-edge, the UK economy is now at a crossroads. It is difficult to think of another time when the UK has been on the verge of two economic out-turns that are so different, but the impact of a no-deal Brexit should not be underestimated. Despite headwinds such as the slowing global economy and limited domestic capacity, the UK economy now has the potential to strengthen over the next 12 months. But a no-deal Brexit could put paid to this upside, triggering the UK’s first recession for a decade.”

Government and Bank of England will be unable to stop a recession

Indeed, the outlook looks grim as the economy contracted by 0.2 percent between April and June, with investment and growth being limited. 

On Monday (9 September), the Resolution Foundation thinktank in its assessment of the UK’s readiness to respond to the next recession, said that the government and the Bank of England were unprepared and that this was a significant risk that policy makers should take seriously. As the think tank noted: “The UK’s macroeconomic policy framework has not kept pace with significant changes to our economic environment and is therefore at risk of leaving the country underprepared for the next recession. That is not a risk policymakers should take lightly.”

 In its key findings, the think tank stressed that the country was facing the biggest risk of recession since 2007, that those of lower incomes would be the most exposed to the recession and that monetary policy will be unable to provide “anything like the level of support it has previously in recessions, reflecting what appears to be a secular decline in the level of interest rates around the world.”

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