Pound Sterling Slides After Data Confirms Government Just Smacked the Economy

Chancellor Rachel Reeves delivers her speech at the Financial and Professional Services Dinner at Mansion House in the City of London. Picture by Kirsty O'Connor / Treasury.

The UK economy is heading into recessionary territory after the UK's government's anti-business budget hits activity.

The Pound to Euro exchange rate spiked after data showed the Eurozone economy slowed sharply in November.

Pound Sterling was then dealt a reality check 30 minutes later when the UK's PMI confirmed that the economy was also under pressure. The survey revealed a significant deterioration in sentiment owing to the October budget.

According to S&P Global, the UK composite PMI fell to 49.9 in November from 51.8, and markets expected today's number to remain the same.

The manufacturing sector has now fallen into contraction mode, with the PMI reading at 48.6, down from 49.9. This would be consistent with a global downturn in manufacturing that the UK is unlikely to avoid.

However, concerns are bubbling in the all-important services sector, the biggest in the economy. The sector is now coming under strain, with a PMI at the make-or-break 50 level, down from 52.

This points to a stark slowdown in the UK economy, with firms indicating a notable drop in confidence following the government's budget.

"The first survey on the health of the economy after the Budget makes for gloomy reading. Businesses have reported falling output for the first time in just over a year while employment has now been cut for two consecutive months," says Chris Williamson, Chief Business Economist at S&P Global Market Intelligence.

The key takeaway from the report is that inflationary pressures facing businesses are building again while employment is starting to decline.

"Underneath the hood, we are seeing stress on hiring plans. Both the manufacturing and services sectors reported falls in hiring plans. And (input) prices – particularly for services – have started to firm – as businesses digest the Budget tax implications," says Sanjay Raja, Deutsche Bank's Chief UK Economist.

According to S&P Global, businesses' average cost burdens increased robustly and accelerated in November. This was driven by the steepest rise in input prices across the service sector since July.

This is the worst-case scenario for the Bank of England. The Bank would be inclined to cut interest rates when faced with signs that the labour market is starting to 'loosen'. However, the Bank's hands will be tied by signs that inflation is rising again.

Foreign exchange markets weren't impressed: GBP/EUR rose to a high of 1.2094 following the release of poor Eurozone data, before falling back to earth at 1.2034 in the wake of the UK print.

The Pound to Dollar exchange rate is under notable pressure, falling to fresh lows at 1.2523. This is understandable given the U.S. economy continues to expand at a strong pace, with further growth to come as Donald Trump's pro-growth policies wait in the wings.

Contrast this to the UK, where the new government smacked businesses with eye-watering tax hikes, minimum wage hikes and additional employment law burdens.

"Business optimism has slumped sharply since the General Election, dropping further in November to hit the lowest since late 2022," says Williamson.

This can keep the Pound under pressure against the Dollar.

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However, given the Eurozone's political malaise and poor sentiment, Pound-Euro can perhaps remain supported for longer.

Following the data, money market pricing shows that investors raised their expectations for the number of interest rate cuts the Bank of England will make next year from two to three.

There remain low odds of a December cut, but a February reduction is now fully priced.

"Sterling has fallen sharply off the back of the data, briefly dropping below the 1.25 level on the dollar this morning. This is partly a consequence of markets racing to price in an additional rate cut from the Bank of England, which is now seen delivering three 25 basis point cuts over the next twelve months, up from just two prior to the data," says Matthew Ryan, Head of Market Strategy at global financial technology firm Ebury.