The UK economy experienced a contraction of 0.5% in July due to a decline in the output of the service sector.

Highlights

• In July, the UK economy experienced a 0.5% contraction, mainly due to a decline in the output of the service sector.
• The UK Services Purchasing Managers' Index (PMI) contracted in August, indicating potential challenges in the future.
• The GDP Report is expected to strongly discourage additional rate hikes by the Bank of England.

UK Economy Contracts in July

The UK economy experienced a contraction in July, as indicated by the GDP report. Previous economic indicators such as retail sales and services sector PMI numbers had already signalled a deteriorating macroeconomic environment.

The July contraction was measured at 0.5%, contrasting with the 0.5% growth seen in June. Economists had anticipated a milder contraction of 0.2%. Notably, the GDP report aligned with the Bank of England's plan to maintain interest rates unchanged.

Sector Contractions

- Service sector output, the main contributor to the overall GDP decline, declined by 0.5%. This was a significant drop compared to the modest 0.2% increase in June.
- Consumer-facing services saw no growth in July, in contrast to the 0.5% growth observed in June.
- Manufacturing production witnessed a decline of 0.8%, resulting in a 0.7% decrease in industrial production.

Implications for the Services Sector

Considering the July Labor Market Overview Report, an increase in unemployment could further impact service sector output. As the services sector accounts for 80% of the UK economy, this suggests a more pronounced contraction in August. This aligns with the August service PMI numbers indicating a deeper contraction.

GBP to USD Reaction to the UK GDP Report

Prior to the release of the GDP report, the GBP/USD pair initially rose to $1.25024 but later declined to $1.24809. Subsequently, after the release of the GDP report, the pair reached a high of $1.24862 before falling to $1.24530. At present, the GBP/USD stands at $1.24580, representing a 0.23% decrease.

Up Next

US CPI Report and Fed Interest Rate Hikes

With the UK GDP report suggesting a halt to BoE rate hikes, attention turns to the US Federal Reserve. Market sentiment towards rate hikes will be influenced by the upcoming US CPI report. Economists anticipate an increase in the US annual inflation rate from 3.2% to 3.6%. However, core inflation is expected to decrease from 4.7% to 4.3%. As market participants focus on core inflation to assess the trajectory of interest rates, higher-than-expected figures may reignite expectations for a September rate hike, and potentially revive concerns of a US economic slowdown.