UK economy continues to weaken, markets bet UK interest rates will top 4% next year

Growth in UK services sector activity slowed less than forecast in August, but an unexpected contraction in manufacturing activity added to mounting pressure on the pound and the UK economy. "With inflation continuing to rise and economic growth data painting a bleak picture, it is difficult to find room for sterling to rise in the long term," said Silicon Valley Bank analyst Sam Cooper.

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British industrial output fell in the past three months for the first time since February 2021, adding to evidence of a slowdown in manufacturing, a Confederation of British Industry (CBI) survey showed on Tuesday. CBI economist Alpesh Paleja said with weakening expectations for future growth, measures were needed to boost confidence in the short to medium term, especially to support vulnerable businesses and consumers amid rising energy prices.

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GBP/USD fell to around 1.17. The pair is expected to continue falling. Changes in risk appetite, two-year rate expectations and commodity prices mostly point to a lower pound. The Bank of England's forecasts point to a recession in the UK, which could also weaken the pound. Political factors may have a bigger impact on the foreign exchange market when the results of the Conservative Party leadership election are announced on September 5. The incoming British prime minister is expected to take meaningful easing, but such fiscal easing may simply be a reminder to the Bank of England of a structural problem plaguing the economy with a huge twin deficit.

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Britain's benchmark interest rate could rise to as high as 4 percent next year, the highest level since the 2008 global financial crisis, according to betting data in the money market. Money market traders widely expect the Bank of England to raise its benchmark interest rate by 235 basis points by May next year, according to interest rate derivatives tied to the date of the BoE's decision, from a current rate of just 1.75%; with inflation at the highest level in 40 years With the market expecting inflation in the UK to continue to rise, more and more traders believe that the Bank of England will be forced to take more aggressive interest rate hikes to control price pressures. Citigroup had previously predicted that UK inflation could soar above 18% early next year due to soaring energy prices.

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UK inflation is expected to exceed 18% in January as the country's energy price cap hits its highest level. Earlier this month, the Bank of England raised interest rates by 50 basis points, the largest rate hike since 1995, and predicted Britain would slip into its longest recession since the global financial crisis. The Bank of England also forecasts that UK inflation will peak at 13.3% in October. At the upcoming three meetings of the Bank of England's Monetary Policy Committee, the Bank of England will further tighten monetary policy by 125 basis points. Annual UK inflation hit 10.1% in July and is increasingly expected to beat MPC's latest forecast.

Soaring energy costs and summer strikes have highlighted Britain's cost-of-living crisis, fueling fears of a further economic slowdown. Weak economic growth prospects in the UK continued to weigh on the pound. The average UK household energy bill could rise above £3,500 a year, reinforcing the headwinds facing consumers. In addition, workers at the Port of Felixstowe, Britain's largest container port, have launched a labor campaign over a labor dispute, highlighting issues surrounding the cost of living crisis and threatening to worsen supply chain problems for British companies.

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Annabel Fiddes, deputy director of economics at S&P Global Market Intelligence: Except for the early stages of the epidemic in early 2020, UK manufacturing output fell at the fastest rate since early 2009. Meanwhile, services sector activity registered its weakest growth since the recovery began in early 2021, although the latest survey also showed that inflationary pressures are easing further, with average input costs rising at their weakest pace in nearly a year, although still well above Historical averages, but easing of cost pressures will provide some comfort to BoE policymakers, and overall, tightening financial conditions due to interest rate hikes, the cost of living crisis, labour shortages and supply chain tensions are all likely to further dampen UK economic performance , the cost of production and living in the UK will remain elevated in the coming months.