The unexpected contraction in UK gross domestic product has triggered significant market reactions today, with the FTSE 100 sliding and the pound falling against major currencies. The Office for National Statistics reported the economy shrank by 0.3% in October, contradicting analysts’ expectations of flat growth and raising concerns about the trajectory of Britain’s economic recovery heading into 2025.
This contraction marks a troubling reversal after three consecutive months of growth. Economists at Barclays Capital noted the decline was broad-based across sectors, with manufacturing output falling 0.8% and services dropping 0.2%. Construction activity, previously a bright spot in the UK economy, decreased by 0.5%, suggesting the slowdown is penetrating multiple segments of economic activity.
“This data point shouldn’t be viewed in isolation, but it certainly raises red flags about economic momentum as we approach year-end,” said Victoria Scholar, head of investment at Interactive Investor. The market reaction was swift, with the FTSE 100 dropping 0.7% to trade around 8,145 points by mid-morning, wiping out much of November’s gains.
Sterling’s performance mirrored equity market weakness, falling 0.4% against the dollar to $1.267 and declining similarly against the euro. Currency strategists at Goldman Sachs suggested this reaction reflects growing doubt about the Bank of England’s ability to maintain its current interest rate path in the face of deteriorating economic conditions.
The GDP contraction has intensified debate about the timing of future interest rate cuts. The Bank of England held rates steady at 5% last week, but market expectations are shifting toward more aggressive easing in early 2025. Swap markets now price in at least three quarter-point cuts by mid-2025, compared to two cuts expected before today’s data release.
For FTSE 100 constituents, the impact varied significantly by sector. Domestic-focused businesses bore the brunt of selling pressure. Retailers like Next and Marks & Spencer saw declines exceeding 2%, while major banks including Lloyds and NatWest Group fell approximately 1.8% on concerns about consumer credit quality and loan demand in a weakening economy.
Energy and resource companies provided some resilience to the index, with BP and Shell posting modest gains as oil prices strengthened on Middle East tensions. These internationally-focused businesses, which generate the majority of revenue overseas, typically benefit from sterling weakness as their foreign earnings translate into more pounds.
The GDP data has meaningful implications for fiscal policy as Chancellor Rachel Reeves prepares her first full budget in early 2025. The Treasury had projected growth of 1.8% for the coming year in its autumn statement, but economists at Deutsche Bank now believe this target faces significant downside risk given the late-2024 weakness.
“Today’s figures complicate the government’s fiscal arithmetic,” explained Sanjay Raja, chief UK economist at Deutsche Bank. “Slower growth typically means lower tax receipts and higher welfare spending, potentially constraining the Chancellor’s room for maneuver on public investment plans crucial for long-term growth.”
Investment managers are reassessing UK asset allocations in light of these developments. BlackRock Investment Institute has reduced its overweight position in UK equities, citing deteriorating economic fundamentals and heightened political uncertainty. However, they maintain that the FTSE 100’s international exposure provides some insulation from domestic economic challenges.
A key question for investors centers on whether October’s contraction represents a temporary setback or the beginning of a more sustained downturn. Business confidence surveys conducted by the Confederation of British Industry suggest a mixed picture, with manufacturing sentiment improving slightly while service sector optimism has weakened.
Small and mid-cap stocks, more exposed to domestic economic conditions, underperformed significantly. The FTSE 250 index fell 1.3%, nearly double the decline of its large-cap counterpart. This disparity highlights investor preference for companies with global revenue streams amid UK-specific economic concerns.
Looking ahead to 2025, analysts remain divided on the FTSE 100’s prospects. Morgan Stanley maintains a year-end 2025 target of 8,700, representing potential upside of approximately 7% from current levels. Their thesis rests on valuation advantages relative to other developed markets and the index’s defensive sector composition.
“While UK economic headwinds are undeniable, the FTSE 100 has historically demonstrated resilience during periods of domestic weakness,” noted Graham Secker, Morgan Stanley’s chief European equity strategist. “The index’s high dividend yield of approximately 3.8% also provides support in an environment where interest rates are expected to decline.”
For everyday investors, financial advisers suggest maintaining diversification while potentially increasing exposure to quality companies with strong balance sheets and sustainable dividend policies. The current volatility may create buying opportunities in fundamentally sound businesses temporarily affected by broader market sentiment.
As market participants digest this disappointing economic data, attention now turns to inflation figures due later this week, which may provide further clues about the path of monetary policy and, consequently, the outlook for UK financial assets heading into 2025.
