Above: Chancellor Rachel Reeves following confirmation she will boost spending by £190BN. Picture by Kirsty O'Connor / Treasury.
The British Pound dropped sharply after the UK's economic growth disappointed in April, raising questions about how the UK government will fund its spending splurge.
According to the ONS, the UK economy contracted by 0.3% month-on-month in April, down from 0.2% in March and below a consensus expectation for -0.1%.
The surprise comes at just the wrong time for the UK, with investors asking whether the economy will be able to deliver the growth required to fund Chancellor Rachel Reeves' £190BN spending splurge.
This GDP reading represents a significant negative surprise for investors, and it is little wonder the Pound to Dollar exchange rate slumped in the minutes following the release, from 1.3588 to 1.3550.
The Pound to Euro exchange rate - already under pressure - went from 1.1790 to 1.1767.
"The UK is watching its currency suffer once again against the euro. Following Tuesday's weak labour market report, today’s monthly GDP report and industrial production data were disappointing, further adding pressure on the Labour government to amend its fiscal plan of significant tax increases and stronger borrowing," says Achilleas Georgolopoulos,
Senior Market Analyst at Trading Point.
Bad news didn't stop with the headline GDP figure: manufacturing production slumped 0.9% m/m in April, which is worse than an already dire -0.8% that was expected.
And the goods trade balance slumped deeper into deficit at -£23.206BN as Britain's exports were eclipsed by imports, meaning the Pound will increasingly rely on foreign investor inflows for support. The Pound potentially risks being caught up in a current account crisis if the goodwill of these foreign investors disappears.
"This week has served up a bleak economic sandwich: grim GDP data on one side, falling employment stats on the other, and a Spending Review in the middle that lacked the ingredients to change either," says Craig Beaumont, Executive Director at the Federation for Small Businesses.
Above: GBP/EUR at 5-minute intervals showing a drop following the ONS data release.
These data come the day after the UK government's Spending Review said routine departmental budgets will grow by about 2.3% per year in real terms, with day-to-day public service spending rising by roughly £190BN more than under the previous government.
The spending raises concerns that debt interest costs are rising; analysts cite £100BN per year in interest payments and a projected £150 billion overall public-sector deficit.
With the UK tax burden at record highs and the cost of issuing long-term debt at levels last seen in 1998, markets will be wondering how the government will pay for its plans.
Chancellor Rachel Reeves hopes the economy will grow fast enough to provide the additional tax revenues; in fact, the whole project rests on the ability of the economy to do the heavy lifting. However, the incoming data simply isn't showing that this economic miracle is coming.
The risk for the Pound is that markets run scared of UK assets as they sense a fiscal crisis is brewing. For the Pound, the downside would be significant.
Some economists think the Chancellor will likely raise taxes again in the Autumn budget, as it becomes clear that she is likely to breach her fiscal rule that states spending must fall as a percentage of GDP in the medium term.
Anna Titareva, an economist at UBS, says to expect weaker growth, potential downgrades to the OBR productivity growth assumption and the recent reversal in some welfare cuts to significantly eat into the already very narrow £9.9bn (0.3% of GDP) fiscal headroom (additional fiscal space without breaking the rules).
"All else equal, weaker growth would imply higher borrowing with the IFS's rule of thumb suggesting that a 1% decline in GDP would add around £11bn in borrowing," explains Titareva.