UK Economy on the Brink

Despite projections of a slowing or even declining British economy, markets remain hopeful for further easing measures to support equities.

Stocks Rising Amid Stagnation

The UK's benchmark stock index experienced a strong start to the week, reaching an all-time high at the beginning of Tuesday trading following the BOE interest rate cut and expectations of additional easing. The market appears to believe that the slowing economy will compel the BOE to ease, supporting domestic firms. Companies listed on the Footsie with a more global presence could also benefit from a broader decline in interest rates, particularly in the EU, given the economic challenges faced by the region. The UK has only recently emerged from a technical recession in late 2024 and may be heading back into another one.

A notable example of the shift in market sentiment has occurred since the beginning of the year with the 180-degree turn by MPC member Catherine Mann. Previously regarded as a staunch hawk, voting to keep rates unchanged in December, she recently sided with the doves, calling for a 50 basis point cut. On Monday, she explained that her change in views was driven by a deterioration in demand. Mann believes inflation will return to the target level more quickly than previously expected this year. Demand could be impacted by a slower economy, leaving people with less disposable income to tolerate price increases, which makes it more difficult for businesses to pass on costs to consumers.

The Outlook and the Data

Mann's views conflict with the consensus of the BOE, which expects inflation to be double the target by the end of the year. However, in the report issued at the last meeting, the BOE halved its economic forecasts for 2025, projecting just 0.75% growth compared to 1.5% previously. Slower growth would presumably restrain the bank from maintaining high interest rates.

Analysts hold a more dour outlook than even the BOE's revised forecasts. They believe the bank's previous outlook was too optimistic and the halving in forecasts merely brought it into line with reality. This means that there could be limited reaction if the upcoming GDP disappoints, as the market already expects worse growth. The consensus is that UK GDP in Q4 fell to -0.1% compared to 0.0% in Q3, narrowly missing entering into a technical recession. However, this could change if Q3 is revised lower.

Cable Eyes Flag Breakout

Cable price action shows a potential rising flag pattern pending a higher breakout around 1.2460, which may open the door to a measured-move projection of 1.2610. The bullish continuation pattern suggests short-term resistance levels at 1.25 and a peak of 1.2250. On the downside, failure to reclaim the upper flag trendline could lead to an initial rejection or a full-blown reversal. Supports lie at 1.2423, 1.2375, and the swing low of 1.2330, followed by 1.2250 in the longer term.

Source: SpreadEx / GBPUSD

Key Takeaways

While the UK economy is projected to slow or potentially enter a recession, markets remain hopeful that the BOE will implement further easing and, in turn, support equities. However, analysts hold a more pessimistic view than the bank's downwardly revised forecasts, suggesting that the market may have a limited reaction to disappointing economic data. Ultimately, the consensus is that the UK GDP in Q4 narrowly missed entering into a technical recession, setting the stage for potential turmoil in the coming months.