The UK economy grew by an average of 0.7% over the three months to May, according to data released by the Office for National Statistics, matching the previous reading. This marks the sixth consecutive month of three-monthly growth, with the services sector making the largest contribution.

The Services Sector's Dominant Role

Within the GDP data, the services sector contributed the most to the growth rate. The UK's macroeconomic structure is highly dependent on services, which account for approximately 75% of economic output. Although sectors like construction and production (including manufacturing, mining, and energy) showed higher growth rates—for instance, construction grew by 1.6%—their lower overall share of the economy means their contribution to GDP was less than that of services.

Concerns Over Stagnant Growth and High Debt

The 0.7% three-month GDP growth rate, while stable, is low in absolute terms, indicating that macroeconomic growth is nearly stagnant. This is a primary concern for holders of the British pound regarding the UK's economic development. Looking at quarterly GDP growth data, the last time the UK's growth exceeded 1% was in the first quarter of 2022. Concurrently, UK government debt as a percentage of GDP remains at a high level, ranging between 93.2% and 95.4% since 2020. The combination of high debt and low growth constrains the potential for pound sterling appreciation.

Bank of England Policy and Yield Curve Implications

The monetary policy of the Bank of England plays a decisive role in the value of the pound. The 1-month government bond yield is 3.82%, while the 3-month yield is 3.98%, a difference of 16 basis points. This spread is less than a typical 25-basis-point rate hike, suggesting a probability of a Bank of England rate hike within three months exists but is low. The 6-month yield stands at 4.07%, approximately 25 basis points higher than the 1-month yield, indicating a high likelihood of a single rate hike within the next six months.

Inflation Outlook and Market Impact

Despite expectations of a rate hike in the medium term, the trajectory of UK inflation appears relatively weak, making immediate monetary policy tightening by the Bank of England less probable in the short term. The UK's core CPI annual rate for May was 2.6%, up from the previous 2.5% but remaining at a low level compared to the 7.1% recorded in May 2023, with the lowest point being 2.5% in April. While the 2.6% core inflation rate is above the 2% target for moderate inflation, the absence of signs of rising inflation data, as seen in the US, means expectations for a Bank of England hike are not as strong as those for the Federal Reserve. The GBP/USD pair rose from a low of 1.3372 to 1.3557, a gain of 185 basis points, largely influenced by US PPI data rather than the UK GDP figures or Bank of England rate hike expectations.