Britain heading for recession, and rate cuts, sooner than expected

Britain may be heading for recession far sooner than markets had anticipated after the economy unexpectedly shrank for the second straight month in May. It will now take something quite special for the UK to avoid an outright contraction in GDP in Q2, which doesn’t appear at all likely quite frankly given the perfect storm of downside risks.

Consumers and businesses are being hammered on multiple fronts. The government’s much maligned business tax increase is proving particularly damaging, as this is not only squeezing bottom lines, but clobbering Britain’s labour market, which is haemorrhaging jobs at a breakneck speed. To make matters worse, an inability of Labour to force through even modest welfare spending cuts means that further tax hikes are practically inevitable in the autumn, which may be a harbinger of further pain ahead.

The data also raises the risk that the Bank of England will be forced into slashing interest rates again as soon as its next meeting in August, with a 25 basis point cut now almost 80% priced in by swap markets. This is keeping sterling under pressure this morning, and the pound has underperformed most of its major peers so far this week.