UK August GDP: Economy & Assets—Set to Collapse?

1. Introduction

TradingKey - The UK is scheduled to release its August GDP figures on 16 October, with the market widely anticipating a 0.1% month-on-month increase in real GDP (Figure 1). If this expectation is fulfilled, it will represent the UK economy’s third consecutive month of recovery, following two straight months of negative growth in April and May this year.

Nevertheless, when taking the broader view, a combination of factors paints a seemingly bleak outlook for the UK: sluggish economic activity, persistently high inflation, a rising government debt load, soaring government bond yields, and the potential introduction of fiscal austerity measures in the upcoming autumn budget. Against this backdrop, many investors and analysts have asserted that the UK economy is on the verge of collapse, warning that its assets will face a "triple slump" in the stock, foreign exchange, and bond markets. However, from our perspective, their judgments are clearly an overstatement. This article aims to demonstrate that the UK is weakening, not collapsing. First, let’s examine the first part of the so-called "triple slump": a plummeting pound?

Figure 1: UK Monthly Real GDP (%, m-o-m) 

Source: Refinitiv, TradingKey

2. First Slump: A Plummeting Pound?

Since the middle of July this year, the British pound has entered a range-bound trading phase against the US dollar (Figure 2). The main factors driving this trend are the political uncertainties in the UK, which have been offset by the rising expectations of the Federal Reserve restarting its interest rate cut cycle—these two forces have essentially neutralised each other's impacts. Looking ahead, the pound's future movement will be dominated by three key factors:

First, the UK government has already compromised on the spending cut plans outlined in the Welfare Reform Act due to opposition from politicians within the Labour Party. However, the difficulty in implementing this plan will exacerbate the fiscal deficit. According to calculations by UK Chancellor of the Exchequer Rachel Reeves, the current fiscal gap may have reached £20 billion to £40 billion. At this stage, the government has not yet clearly proposed a specific plan to fill this gap, which not only creates uncertainty for investors but also exerts bearish pressure on the pound.

Second, uncertainties at the UK political level have been on the rise. Coupled with the slowdown in global economic growth momentum, the UK's economic growth rate is expected to decline further. In turn, the weak economic performance will exert additional downward pressure on the British pound.

Third, affected by the high inflation issue, the Bank of England is highly likely to slow down the pace of interest rate cuts. In contrast, the Federal Reserve officially launched a new round of interest rate cuts on 17 September, and it is expected to implement two more interest rate cuts within this year, with each cut being 25 basis points. As the Bank of England lags behind the Federal Reserve in its interest rate cut progress, the policy interest rate differential between the U.S. and the UK will narrow, and may even reverse. This situation will provide support for the GBP/USD exchange rate.

Overall, we believe that the impacts of the first two factors will offset those of the third factor. This will keep GBP/USD fluctuating within its current range, and the probability of a sharp plunge in the British pound is extremely low. Having addressed the first point, let’s now examine the second: a UK stock market crash?

Figure 2: GBP/USD

Source: TradingKey

3. Second Slump: A UK Stock Market Crash?

The UK's FTSE 100 Index has recently hit a record high, and its future trend will be dominated by the rivalry between bullish and bearish forces. From the perspective of bearish factors, the coexistence of slowing economic growth and high inflation has left the UK economy showing signs of stagflation. Although the current degree of stagflation is still mild, it will still exert downward pressure on the stock market. On the bullish side, while high inflation has led the Bank of England to slow down its interest rate cut pace, the broader direction of accommodative monetary policy remains unchanged. The gradual release of liquidity will continue to provide support for the stock market.

Meanwhile, over 70% of the revenue of UK-listed companies comes from overseas markets, which results in a strong correlation between the performance of UK stocks and that of overseas stock markets, particularly the US stock market (Figure 3). Driven by preventive interest rate cuts, the US stock market is expected to continue its upward trend, and the spillover effect it generates may provide a boost to UK stocks. Based on a comprehensive assessment, the probability of a stock market crash in the UK in the short to medium term is nearly zero. Our baseline expectation is that UK stocks will remain on an upward trajectory; however, constrained by negative factors, their growth may not match that of the US stock market.

It should be noted that while we anticipate the FTSE 100 Index to continue its upward trend, some sectors and individual stocks may underperform the broader market or even experience short-term declines. In the Autumn Budget to be released on 26 November, the Chancellor of the Exchequer is highly likely to raise taxes to fill the fiscal gap. Sectors such as banking, gambling, and real estate are expected to be the key areas affected by tax adjustments. Therefore, when investing in UK stocks, investors should avoid stocks in these sectors. For example, in the banking sector, there are Lloyds Banking Group, HSBC Holdings, NatWest Group, and Barclays; in the gambling sector, Flutter Entertainment, Entain Group, and Rank Group; and in the real estate sector, Land Securities, Bovis Homes Group, and Berkeley Group Holdings. After analysing the second risk factor, let's move on to the third one: a UK bond market collapse?

Figure 3: FTSE 100 vs. S&P 500

Source: Refinitiv, TradingKey

4. Third Slump: A UK Bond Market Collapse?

Due to the weakened structural demand for long-term government bonds from pension funds, the yield on UK 30-year government bonds has surged sharply recently. This change has, in turn, led to a rapid steepening of the government bond yield curve. However, when assessing the future trend, the likelihood of a further significant rise in long-term government bond yields remains extremely low, primarily driven by two key factors. First, the Bank of England has reduced the scale of quantitative tightening (QT) from £100 billion to £70 billion. Second, the UK Debt Management Office (DMO), in pursuit of its "strategy to shorten the maturity of bond issuances", has cut the proportion of long-term government bond issuances from nearly 20% last year to approximately 10%. Both measures will reduce the supply of long-term government bonds in the market, which will push up their prices and consequently lower their yields.

In the short-term government bond sector, although the Bank of England has slowed the pace of interest rate cuts due to high inflation, it has not brought the rate-cutting cycle to an end. Driven by this factor, short-term government bond yields are expected to decline slightly and gradually. From an overall perspective, the "short-term decline and long-term rise" pattern exhibited by yields over the past year is unlikely to continue (Figure 4); looking ahead, the entire yield curve is projected to shift slightly downward. In other words, the probability of a collapse in UK government bonds triggered by a sharp upward movement of this curve is extremely low.

To sum up, the judgment that the risk of a simultaneous slump in stocks, foreign exchange, and bonds (a "triple slump") is extremely low cannot be made without researching the overall economy. Next, we will conduct a detailed analysis of the UK's macroeconomic conditions.

Figure 4: UK Gilt Yield Curve (%)

Source: Refinitiv, TradingKey

5. Macroeconomic Outlook

5.1 Pessimists’ Focus: UK Government Debt

A core topic consistently dominates discussions among investors and analysts who hold a bearish view on the UK economy: the recent sharp surge in UK government bond yields. On the surface, the immediate driver behind this significant yield increase is a marked decline in market demand. However, the deeper issue stems from the UK’s persistently high debt levels, compounded by the government’s challenge in curbing expenditure. Specifically, expenditures on healthcare and pensions not only account for a large proportion of total spending but also fall into the category of rigid expenditures that cannot be easily reduced. Spending on Personal Independence Payment (PIP) has been rising substantially year by year, driven by the continuous relaxation of disability definitions and the trend of population ageing. Additionally, Winter Fuel Payments also represent an expenditure item that is difficult to slash.

Affected by this series of factors, the UK government's net and gross debt have increased from £1.57 trillion and £1.75 trillion in 2016 to approximately £2.8 trillion and £3 trillion at present. Over the past decade, both indicators have risen by more than 75% (Figure 5.1.1). Given the high level of government debt, the market has grown concerned about its debt-servicing capacity. This concern directly pushed the 30-year government bond yield up to 5.69% on 2 September, marking the highest level since 1998 (Figure 5.1.2). While we acknowledge that the high government debt has exerted a profound impact on the UK economy, we should also note that the UK economy is not without its merits.

Figure 5.1.1: UK General Government Debt (Billion Pounds)

Source: Refinitiv, TradingKey

Figure 5.1.2: UK 30-Year Gilt Yield (%)

Source: Refinitiv, TradingKey

5.2 Economic Growth

In the first six months of this year, the UK economy maintained a relatively strong growth momentum. Specifically, the real GDP grew by 0.7% quarter-on-quarter in the first quarter and 0.3% quarter-on-quarter in the second quarter. Driven by this growth trend, the year-on-year growth rates for the two quarters reached 1.7% and 1.4% respectively (Figure 5.2). While the UK currently faces such challenges as concerns over government debt, a lacklustre performance in the labour market, and potential fiscal austerity measures that may be included in the autumn budget, high-frequency data have not shown a sharp decline.

After the month-on-month growth of the UK's real GDP remained flat at 0% in July, a modest positive growth is expected in August. Additionally, from the demand side, following a negative growth in the UK's retail sales in May, there was a significant recovery between June and August, with the average year-on-year growth rate over these three months reaching 0.8%. Turning to the supply side, while the Manufacturing PMI remains in a sluggish state, the Services PMI— which accounts for a larger share of the UK economy— stays in the expansionary range, with a reading of 50.8. Taking the above factors into consideration, we anticipate that the UK's economic growth will continue to slow down; however, the claim of a "collapse" is utterly unfounded.

Figure 5.2: UK Quarterly Real GDP (%)

Source: Refinitiv, TradingKey

5.3 Inflation

Since the UK's headline CPI fell to a low of 1.7% in September last year, the indicator has been rising month by month. By August this year, the headline CPI had climbed to a high of 3.8%. Over the same one-year period, the UK's core CPI has also remained above 3%. This indicates that both the headline inflation rate and the core inflation rate are well above the 2% target set by the Bank of England (Figure 5.3).

Looking ahead, however, we anticipate a gradual decline in UK inflation, which can be explained by two key factors. First, most of the drivers that have pushed up the headline inflation rate this year are temporary, such as hikes in water and electricity bills, and employers passing on part of their increased tax burdens to consumers. As energy prices gradually stabilise, inflationary pressures are expected to ease in the coming quarters. Second, the slowdown in the UK’s economic growth will curb the sustained rise in inflation from the demand side. In summary, given that the UK economy will slow but not enter a recession, and that the current high inflation is projected to fall gradually, we believe that while the UK economy is showing signs of stagflation, the severity will not be particularly acute.

Figure 5.3: UK CPI (%, y-o-y)

Source: Refinitiv, TradingKey

5.4 Monetary Policy

To address the economic slowdown, the Bank of England launched an interest rate cut cycle in August last year. So far, the central bank has lowered its benchmark interest rate from 5.25% to 4%, representing a cumulative reduction of 125 basis points (Figure 5.4). Looking ahead, given that both the UK's headline inflation and core inflation remain significantly above the target level in the short term, the Bank of England is expected to pause its easing cycle in the coming months. However, in the medium term, as inflation falls and economic growth continues to slow, the overall direction of the central bank's accommodative monetary policy is not expected to change. It is projected that by the end of 2026 or the beginning of 2027, the Bank of England's benchmark interest rate will drop to 3%.

Figure 5.4: BoE Policy Rate (%) 

Source: Refinitiv, TradingKey

6. Conclusion

All in all, we acknowledge that the UK economy does face long-term structural issues. However, it would be an overstatement to conclude that the UK economy will collapse and its assets will plummet solely based on selective negative news and short-term market fluctuations. Based on the above analysis, our baseline assessment is as follows: the UK economy is confronting mild stagflation, the GBP/USD exchange rate will continue to fluctuate within a range, the UK stock market will still see slight growth, and the UK government bond yield curve will shift slightly downward. As for the economic collapse and the "triple slump" of stocks, the exchange rate, and bonds predicted by pessimists, we believe the probability of such a scenario occurring is extremely low.

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