Pound Sterling (GBP) has decreased against the US Dollar (USD) and Euro (EUR) as UK economic activity experienced an unexpected contraction in January. Real GDP fell by 0.1% month-on-month, contrary to the predicted growth of 0.1%, following a 0.4% rise in December.
This decline was influenced by a 0.9% decrease in the production sector and a 0.2% drop in construction output, while the service sector recorded a slight 0.1% increase. The Bank of England’s (BOE) forecast for Q1 remains at 0.4% quarter-on-quarter, albeit likely to be unmet.
Bank Of England Policy Stance
Despite the economic backdrop, the BOE is likely to pause any easing measures in its March 20 meeting due to persistent services inflation at 5% year-on-year. The swaps market anticipates potential cuts of 50 basis points over the next year, alongside minimal odds for an additional 25 basis points cut, potentially impacting GBP against the EUR.
What we are seeing here is a Pound that has weakened, with economic output falling when a small gain was expected. December saw some growth, but January reversed that, largely because production took a hit, and construction also shrank.
As it stands, the Bank of England expected the economy to grow moderately in the first quarter. Given this drop in activity, that forecast now looks difficult to reach. But despite a sluggish economy, inflation in services remains high. The Monetary Policy Committee is unlikely to lower interest rates this month because costs in that area are not yet under control.
Market Expectations And Currency Impact
Markets, however, are pricing in rate cuts ahead, estimating reductions worth about half a percentage point over the next year. There is also a slim chance of an additional 25-basis point cut, which could come into the equation later on. Should those rate reductions materialise, the Pound might struggle further, particularly against the Euro.
For those trading derivatives linked to GBP, the pressure is coming from two sides. The economic slowdown suggests potential weakness, yet the Bank’s reluctance to act quickly on rates could limit losses in the shorter term. Given the current pricing in swaps markets, any shift in expectations could alter the currency’s path.
It is worth watching how policymakers respond in their March decision and how inflation, particularly in services, evolves. Any further surprises in economic data may shift rate expectations, and in turn, market movements. Knowing where traders have already positioned themselves could also be useful, as changes in sentiment tend to move ahead of announcements.
