September GDP report to test BOE's hawkish resolve

The UK is set to publish its September monthly and third-quarter GDP numbers at 0700 GMT on Wednesday. Financial markets are asking how weak the data must be to convince the Bank of England to halt its rate-hiking cycle.

Economists expect no change in September output, after a 0.1% rise in August. That followed a more robust 0.4% increase in July, pointing to uneven momentum over the recent quarter.

Still, the broader picture is less soft than monthly readings suggest. GDP expanded 0.7% in the three months through August, supported mainly by services. Manufacturing and construction also added to growth, though less convincingly.

Alongside the monthly figures, the preliminary Q3 GDP estimate will be released. That should give a better indication of whether the economy is holding up or struggling under the weight of higher borrowing costs and rising energy prices. Energy costs have improved recently but their effects will take time to feed through.

On balance, a downside surprise could weigh on sterling and reduce expectations for further BOE tightening. But unless the numbers are particularly ugly, the report is unlikely to materially change the central bank's plans for December.

Markets currently price in about a 71% probability of another 25 basis point rate increase next month, following the November move that took the bank rate to 4.25%. The reasoning behind such aggressive pricing is straightforward: inflation remains the bigger threat.

UK headline annual inflation rose to 3.5% in September, while core annual inflation climbed to 2.8%, with services inflation proving sticky at 3.7%. The BOE also projects headline inflation reaching around 5% by the middle of next year. That is hardly a reassuring backdrop as the year draws to a close.

Policymakers thus face an uncomfortable balancing act. Weakening growth prospects could eventually force a more difficult decision, but for now the greater danger is allowing inflation pressures to become entrenched.

In that context, it would likely take considerably more than one disappointing growth report to shift the BOE from its current hawkish course.