UK economy shrinks, testing BoE's resolve on rates

By William Schomberg and Andy Bruce

LONDON (Reuters) -Britain's economy shrank in October, official data showed on Wednesday, raising the risk of a recession and testing the Bank of England's resolve to stick to its tough anti-inflation line against cutting interest rates from their 15-year high.

Gross domestic product (GDP) fell by 0.3% from September, the Office for National Statistics said, adding that exceptionally wet weather might have impacted the data.

Economists polled by Reuters had expected no change in GDP in October.

It was the first time since July that GDP had shrunk on a month-by-month basis.

Sterling fell by about a third of a cent against the U.S. dollar and was weaker against the euro too.

Investors added to their bets on the BoE starting to cut interest rates in June 2024, and the yield on 10-year British government bonds fell to its lowest since May.

However, the central bank is widely expected to keep Bank Rate at 5.25% on Thursday and signal once again that it is not close to cutting them as it tries to ensure that Britain's still-high inflation rate - 4.6% at its most recent reading in October - is brought under control.

Paul Dales, chief UK economist at Capital Economics, said the October data suggested Britain might be in a recession.

"That may nudge the Bank of England a little closer to cutting interest rates, although when leaving rates at 5.25% tomorrow the Bank will probably push back against the idea of near-term rate cuts," Dales said.

Elizabeth Martins, at HSBC, said she still expected another 6-3 vote by the BoE's Monetary Policy Committee to keep rates unchanged, but the weak GDP data - published a day after signs of slowing wage growth - could prompt some of the three MPC members who want to raise rate to join the no-change majority.

"If the BoE's hawks wanted to push back on market expectations of rate cuts starting mid-next year, the data are giving them very little work with," Martins said.

In the three months to October, GDP flat-lined.

Britain's economy avoided a contraction in the July-to-September period - when it also showed no change - but some analysts think it remains at risk of a shallow recession in late 2023 and early 2024 after the BoE's increases in interest rates.

FLAT-LINING

The economy has flat-lined through most of 2023 with economic output now back at its January level.

Britain's huge services sector shrank by 0.2% in October. Manufacturing and construction contracted by 1.1% and 0.5%.

The economy was 2.0% bigger than immediately before the COVID-19 pandemic hit Britain in early 2020, a stronger performance than thought before recent ONS data revisions but another weak period for living standards nonetheless.

Prime Minister Rishi Sunak and finance minister Jeremy Hunt have promised to speed up growth but no big pickup is expected before an election that Sunak must call before January 2025.

"October’s negative outturn puts the prime minister’s target to get the economy growing in jeopardy, with high inflation and borrowing costs likely to suppress economic activity in November and December," Suren Thiru, economics director at ICAEW, an accountancy body, said.

Hunt said it was inevitable that the economy would feel the hit from higher interest rates but it was well placed to start growing again after he announced cuts to some business taxes last month.

Separate data showed Britain posted a larger-than-expected goods trade deficit in October at 17 billion pounds ($21.30 billion), against expectations for a 14-billion-pound gap.

Exports to the European Union - which is similarly at risk of recession - fell sharply. Adjusted for inflation, goods exports to the bloc that Britain used to belong to fell for a third month in a row and hit their lowest level since mid-2009, excluding the large swings seen during the COVID-19 pandemic.

($1 = 0.7982 pounds)

UK economy shrinks, testing BoE's resolve on rates