Economy shrank 0.2% in third quarter, putting UK on road to recession

The UK economy contracted in the third quarter of the year, official figures showed this morning, raising the prospect of a recession by the end of the year.

Data from the Office for National Statistics showed the economy contracted by 0.2 per cent in the three months to September, after a 0.2 per cent expansion in the second quarter.

The decline was not as deep as economists’ forecasts of a 0.5 per cent fall but another drop in gross domestic product in the final three months of the year would mean that the UK is formally in a recession.

Economists and forecasters widely expect a recession to hit by the end of the year, driven by double-digit inflation, rising interest rates and the cost of living crisis.

The data suggest that the UK is the only G7 economy not to have recovered fully to its pre-Covid level. This month the Bank of England warned that the UK risks entering the longest recession in 100 years.

Monthly GDP between August and September fell by 0.6 per cent, according to the Office for National Statistics, and August’s GDP figure was revised from minus 0.3 per cent to 0.1 per cent.

Economic growth in September was hit by the Queen’s funeral when many businesses were shut. The ONS said that about half the decline in September’s GDP could be attributed to the additional bank holiday.

The drop in GDP was driven by shrinking output in the UK’s dominant services sector, which accounts for about three quarters of the economy. The services industry had boomed after the end of pandemic lockdown measures but consumers and businesses are being squeezed by high inflation and falling real incomes.

The grim economic outlook comes before next Thursday’s autumn statement, in which Jeremy Hunt, the chancellor, is expected to announce tens of billions in tax rises and spending cuts. Falling government spending and a rising tax burden on households and businesses will act as a further drag on growth next year.

Responding to the figures, the chancellor said: “I am under no illusion that there is a tough road ahead, one which will require extremely difficult decisions to restore confidence and economic stability. But to achieve long-term, sustainable growth we need to grip inflation, balance the books and get debt falling. There is no other way.”

The Bank of England forecast last week that the UK would enter a five-quarter recession starting this year if interest rates were maintained at 3 per cent. Should rates rise above 5 per cent the economy would contract until 2024, it said.

Alpesh Paleja, lead economist at the CBI, said: “The latest GDP data probably marks the start of a downturn for the UK economy, which could last for most of the coming year. Even accounting for an extra bank holiday in September, it’s clear that underlying activity has weakened, as shown by our recent business surveys. A weaker growth outlook and persistently high inflation will make for some difficult decisions on economic policy.”

Yael Selfin, chief economist at KPMG, said the recession would last until next year and amount to a 1.6 per cent fall in the size of the economy. “A turn to a more austere fiscal policy expected from next week’s autumn statement could contribute to prolonging any downturn,” she said.

Martin McTague, chairman of the Federation of Small Businesses, said the shrinking economy was “dreadful news for small businesses that have been facing increasing recessionary pressures for months now”.

He added: “Lower levels of reserves and resources mean small businesses are more vulnerable to downturns and at a time when confidence is deteriorating in both consumers and businesses. The government must demonstrate that it has grasped the scale of the issue.”

David Bharier, head of research at the British Chambers of Commerce, said: “Today’s figures solidify the picture that the economy is moving towards recession, if not already in one. Our research clearly shows that business confidence has fallen significantly in recent months. Inflation, driven by energy costs and supply chain disruption, is by far and away the top factor of concern, wiping out margins for many SMEs.

“The chancellor’s autumn statement must reassure the financial markets after the recent self-inflicted turmoil. But businesses need to see a long-term economic plan that invests in people, skills and infrastructure and radically improves our trading relationships with key markets, not least across Europe.”

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said: “Looking ahead, GDP in October likely will reverse some of September’s 0.6 per cent month-to-month drop, which was partly the consequence of the lost working day for the Queen’s funeral.

“But the very low level of demand indicators — the orders index of the composite PMI survey fell to just 46.8 in October, from 48.6 in September — and the extremely low level of consumers’ confidence suggests that GDP likely will fall again in Q4.

“Meanwhile, the outlook for a squeeze on households’ disposable incomes from both fiscal and monetary policy, as well as for further falls in real wages in the first half of next year, suggests that GDP will continue to fall throughout 2023. Higher interest rates also will take a toll on both business and residential investment, while history suggests that sterling’s depreciation will result in only a modest net trade boost to GDP.”