Pound Sterling Drops on Surprise GDP Contraction

Construction growth disappointed in today's GDP release. Above: The Chancellor of the Exchequer visits Fairham housing development in Nottingham. Picture by Simon Walker / Deputy Prime Minister's Office.

The British Pound fell after January's GDP read at -0.1%.

UK economic output fell from 0.4% in December to -0.1% in January, according to new data from the ONS, disappointing market expectations for growth of 0.1%.

The miss in expectations triggered currency weakness, with the Pound-to-Euro exchange rate dropping to 1.1927 in the minutes following the release and the Pound-to-Dollar exchange rate falling to 1.2922.

Above: GBP/EUR at one-minute intervals showing the post-release fall. | Investment Banks Are Downgrading Pound vs Euro – What does it mean for you?A wave of new forecasts suggests upside potential for the euro. Read more.

Over the three months to January 2025, GDP increased by 0.2%, largely driven by December's surprisingly strong showing.

The services sector, the economy's biggest, grew by just 0.1% in January 2025, following a 0.4% rise in December 2024.

"Recession starts here," says Nicholas Hyett, Investment Manager at Wealth Club. "Services too has slowed dramatically, particularly in sectors like accommodation and food services which expect to be hit hard by higher living wage and employer national insurance contributions in April."

January's weakness was concentrated in production, which fell by 0.9% in January 2025, reversing a 0.5% increase in December 2024. Manufacturing output declined by 1.1%, primarily due to drops in basic metals (-3.3%) and pharmaceuticals (-3.1%).

Mining and quarrying fell by 3.3%, mainly due to a 3.7% decline in crude petroleum and natural gas extraction.

Construction output was also disappointing, with a decline of 0.2% recorded in January 2025, the same as in December.

The data is probably not weak enough to shift the dial on next week's Bank of England interest rate decision, which should result in interest rates being left unchanged.

Given this, we would expect weakness in Pound Sterling to be relatively shallow.

"The 0.1% contraction in GDP adds to the growing pressure on the Bank of England to reduce the base rate. However, it’s unlikely to be enough to trigger an immediate rate cut next week. Inflation remains the key concern, and the Bank will want to see sustained progress before acting. However, this latest economic weakness could shift expectations for a summer rate cut," says Jamie Elvin, Director at Strive Mortgages.

The GDP figures will disappoint Chancellor Rachel Reeves, who desperately needs growth to pick up in order to keep the public finances on an even keel.

Reeves is expected to announce spending cuts at next week's spending review as faltering growth and rising debt costs leave her with a growing black hole in the finances.

Spending reductions and April's looming tax hikes will weigh on growth, which points to another lacklustre year ahead for the economy.

Employer taxes and the minimum wage rise in April, which will heap pressure on UK businesses. More stringent hiring regulations are also being pushed through by the Labour government, making employment more rigid and less appetising for business owners.

"Downside growth risks remain from the potential for a softer labour market and an uptick in inflation. And rising global trade tensions could also keep business investment on the sidelines," says Ben Jones, CBI Lead Economist.