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Sterling attracted heavy buying as UK factory activity contracted sharply.
Cuts in the UK labor market, higher wage growth and weak factory activity are creating more trouble for Bank of England policymakers.
Bank of England official Breeden warned that inflation risks are tilted to the upside.
Sterling (GBP) remained quoted on Wednesday after the Office for National Statistics (ONS) reported that the UK economy shrank by 0.5% in July and factory activity contracted sharply as the demand outlook worsened. The GBP/USD currency pair suffered a strong sell-off as businesses remained reluctant to utilize full capacity amid an economic slowdown triggered by higher interest rates from the Bank of England (BOE).
After deep job losses and weak factory activity in July, it is clear that the UK economy cannot bear the burden of restrictive monetary policy. At the same time, strong wage growth has heightened the risk of upward inflation, and the Bank of England will need to raise interest rates further to curb the highest inflation rate among the Group of Seven (G7) countries. Sarah Breeden, who will succeed Jon Cunliffe, deputy governor of the Bank of England, in November also said that inflation risks are tilted to the upside.
Daily Summary Market Moves: UK economy shrinks, GBP faces sell-off
Sterling fell vertically as UK factory activity contracted in July, showing the impact of the Bank of England raising interest rates.
The Office for National Statistics reported that monthly industrial production shrank by 0.7%, beating expectations for a 0.6% contraction. In June, the economic indicator grew 1.8%.
Monthly manufacturing production shrank 0.8%, while investors expected a 1.0% contraction. Economic data for the same period a month ago was for growth of 2.4%.
Monthly gross domestic product (GDP) data shrank by 0.5%, after expanding by 0.5% in June. Investors expected a 0.2% contraction.
The goods trade balance remained below expectations and previously reported data, suggesting trading volumes were driven by a gloomy economic outlook.
A labor market report for August showed on Tuesday that wage growth remained strong, while job cuts outstripped hiring, as British businesses remained concerned about a deteriorating demand environment.
UK employers shed 207,000 jobs in the three months to July, beating market forecasts of 185,000. The labor market lost 66,000 jobs in the three months to June.
The unemployment rate rose to 4.3% in the quarter ended July from 4.2% previously, in line with market participants’ expectations.
Average earnings (excluding bonuses) for the three months through July were 7.8%, in line with expectations and the previous reading. Wage growth, including bonuses, rose to 8.5%, compared with forecasts and previous estimates of 8.2%.
The labor market report accelerated uncertainty over the outlook for interest rates, as strong wage growth could force Bank of England policymakers to discuss a rate hike, although bleak labor demand could act as a constraint on more rate hikes.
Sarah Breeden, who will succeed Bank of England deputy governor Jon Cunliffe in November, believes inflation risks are tilted to the upside. She predicted price stability would be achieved within two years.
For monetary policy in September, investors expect the Bank of England to raise interest rates for the 15th consecutive time. Expectations are high for a 25 basis point (bps) rate hike, which would push rates to 5.50%.
Sentiment remained cautious as investors awaited U.S. inflation data for August due out at 12:30 GMT.
The U.S. monthly headline consumer price index (CPI) and core inflation are set to increase by 0.6% and 0.2% respectively. Headline inflation will reflect the impact of the recent rebound in oil prices.
Global oil prices have risen by as much as 40% since May, pushing up gasoline prices, squeezing households’ real income and increasing household burdens. That could cause more trouble for Federal Reserve policymakers, forcing them to raise interest rates again this year.
The dollar showed volatility compression ahead of inflation data. August’s inflation data takes on added importance because it will be the last data the Fed considers before its Sept. 20 rate decision.
