Image © Pound Sterling Live
Pound sterling is higher after the UK economy grew faster than expected in July, raising the odds of a Bank of England rate rise this month.
The Bank of England is running out of excuses not to raise rates: inflation is well above the 2.0% target and will rise further, the labour market has stabilised and the economy is growing faster than expected.
Economic outperformance was reinforced Friday after the ONS said the economy grew 0.4% month-on-month in July, outperforming a market expectation for a contraction of 0.1%.
"It just keeps growing," says Sanjay Raja, Chief UK Economist at Deutsche Bank. "Yet again, the UK economy surprised – and surprised in a good way."
Growth was centred on professional services and IT, suggesting that the UK is seeing an AI-inspired investment boom as companies race to tool up for the new age.
"If we look at the services sector in the UK – the engine of growth in the country – signs of AI capex are coming through even more," says Raja.
How did the pound respond to the data?
Pound sterling rose in response to news the economy grew much faster than anyone expected: the pound-to-euro rose noticeably in the minutes following the release, rising from 1.1635 to 1.1650.
The pound-to-dollar was slightly more lackadaisical, rising from 1.3510 to 1.3520, perhaps because the USD has its eyes on the big-ticket issues Stateside.
Nevertheless, the data falls squarely in line with Pound Sterling Live's House View that looks for the GBP to outperform consensus expectations into year-end on account of the economy beating expectations.
Why is the pound benefiting from news that the economy grew faster than expected?
The pound is outperforming because a stronger economy raises pressure on the Bank of England to raise interest rates in September, and later again in the year.
"Evidence that GDP has not been as adversely hit as expected as a consequence of the energy shock is becoming more of a theme, and one that adds extra pressure on the BoE," says Sam Hill, analyst at Lloyds Bank.
In short, the data is aligning with the market's view that several rate increases are likely.
The Bank has to consider:
- inflation that's some one percent above its target, and will likely rise further.
- an economy that is growing faster than its own forecasts suggest
- and a labour market that's stabilised and could, in fact, turn a corner.
Bank of England Governor Andrew Bailey was at pains to push back against expecting rate hikes when he appeared before the Treasury Select Committee this week, but his objections to higher rates are wearing thin.
Image courtesy of Lloyds Bank.
"Annualised growth is now tracking at 2.4%. Households and businesses are still spending – despite the unfolding energy shock impacting disposable incomes," explains Raja.
The Bank of England was looking for a negative shock, but the opposite might be happening.
This is exactly the kind of setup that the pound would like: interest rate hikes that are delivered on the back of economic outperformance.
The downside risk scenarios nevertheless remain
Pound Sterling Live predicts the pound will remain well supported into year-end, but our House View also warns readers to be wary that shocks are possible.
We're watching two potential banana peels:
- global bond markets are under severe pressure, and that's pushing up borrowing costs
- the budget will be increasingly difficult for Chancellor Healey to navigate, any slip ups and the pound will be the pressure release valve
On Thursday the UK ten-year yield surged to its highest level in 19 years and the problem for sterling is that yields are rising faster in the UK than anywhere else.
"The UK gilt market’s high beta is on display again today as 10-year yields surge to nearly 5.40% amid this global sell-off—and this in the run-up to the government delivering its first, highly anticipated budget on October 28," says Mohamed A. El-Erian, Former CEO at Pimco, which is one of the world's biggest bond investor.
This means that the UK will likely be the first country to experience crisis conditions as a result of a global phenomenon, courtesy of successive governments delivering inflationary fiscal policies.
It's one to watch, but for now the pound is benefiting from the strong growth figures.
