Recession Confirmed: Pound Sterling Extends Falls Against Euro and Dollar

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The British Pound dropped to fresh lows for the week after it was confirmed the UK fell into recession in the second half of 2023.

The Pound to Euro exchange rate fell to 1.17 from 1.1710 in the minutes after the ONS said the UK economy shrank 0.3% quarter-on-quarter in the final quarter of 2023, which makes for two consecutive quarters of contraction owing to Q3's shrinkage.

The development was expected; however, the figure was worse than the -0.1% reading the market expected, which explains why the Pound to Dollar rate dipped to 1.2558 from 1.2566.

Above: GBP/USD (top) and GBP/EUR reaction to GDP data release. Track GBP with your own custom rate alerts. Set Up Here

The word recession carries disappointing connotations, but we would expect the FX impact to be relatively limited owing to the backwards-looking nature of these figures: the market is more interested in what happened in January (as per Wednesday's inflation release) and February (that's why next week's PMI survey will be watched closely).

Survey data for January suggests the economy is recovering, which should underpin the Pound in a forward-looking FX market.

"Weak UK GDP data suggests some potential for profit-taking in long GBP positions. That said, we would favour buying GBP on dips vs. the EUR and look for a move in EUR/GBP to 0.84 in the latter part of this year," says Jane Foley, Senior FX Strategist at Rabobank.

These quarterly growth data are just the latest to confirm that 2023 was a poor year for the UK, with GDP estimated to have increased by just 0.1% in the year compared with 2022.

Incredibly, GDP per capita - or GDP per person - read at -0.7% in the final quarter. In fact, it contracted in every quarter of 2023 as record immigration outstripped economic growth.

There were falls in all three main sectors in the latest quarter, with declines of 0.2% in services, 1.0% in production, and 1.3% in construction output. There was a fall in the volume of net trade, household spending and government consumption in Q4.

"With inflation lower than expected this week, news that the UK is in recession will lead to growing pressure for the Bank of England to cut interest rates," says Nicholas Hyett, Investment Analyst, Wealth Club.

Market expectations for a rate cut rose following Wednesday's release of inflation data for January, with the market now seeing the odds of a June rate cut at above 75% following the GDP release, from less than 50% ahead of the inflation reading. 

The Pound has fallen in response to this expectation shift, and near-term trends are likely to be soft, although the medium-term picture remains constructive.

"GBP/USD is trading back in the mid-$1.25 region and is grappling with its 200-day moving average. Should this key support give way, we’re eying the 100-day moving average, located at $1.25, as the next downside target in the short-term," says George Vessey, Lead FX Strategist at Convera.

"Despite the very short-term outlook for sterling potentially looking weaker, we still think 2024 should see sterling stage a shallow recovery against the US dollar and euro, mainly due to the higher UK interest rate outlook with less rate cuts expected by the BoE compared to the Fed and ECB," adds Vessey.