22 June 2022
The economy is already in a recession. There was a 0.3% month-on-month drop in GDP in August, and it will inevitably take another dip in September due to the extra Bank Holiday for the Queen’s funeral.
It’s likely that the current recession will last until the third quarter of 2023 as the current cost-of-living crisis morphs into a cost-of-borrowing crisis. Whether the recession continues into 2024 will largely depend on how tightly the government embraces any austerity measures.
Given the incredibly tight labour market, we don’t think today’s data will be enough to dissuade the Monetary Policy Committee from a super-sized rate hike of a full 1% in November.
Hospitality and manufacturing bearing the brunt
Admittedly, the fall in August was driven in part by a couple of one-off factors. Mining dropped by -8.2% m/m, but this was due to planned maintenance. Output in the health sector dropped by 1.3% m/m as coronavirus-related activity in the NHS dropped again. However, there were clear signs of sharp contraction in those sectors most reliant on disposable income.
Output in the recreation and entertainment sector dropped by a whopping 5% m/m, and output in hotels and restaurants fell by 1.8% m/m. The retail sector has now contracted for four consecutive months. Overall, consumer-facing services fell by 1.8% m/m and it is still an extraordinary 8.9% below its pre-pandemic level. All this is clear evidence that consumers are starting to rein in spending in response to soaring inflation and falling real wages.
Manufacturing output fell by 1.6%, its third consecutive month of contraction. The manufacturing industry has been hit not only by a global slowdown in goods trade, but also by a drop in orders from retailers who are seeing their own sales fall sharply.
The only positive was the 0.4% m/m rise in construction output as the sector took on new work.
The hit to GDP in September from the extra public holiday for the Queen’s funeral was probably slightly larger than the 0.2pp blow that resulted from the extra holiday for the Jubilee in June. That can be blamed on a much larger number of business closures than would usually be associated with a normal bank holiday. We’re expecting a 0.5% m/m drop in September, which would mean a 0.6% q/q drop in Q3.
Beyond that, the combination of a cost-of-living crisis and a cost-of-borrowing crisis will dramatically squeeze disposable household incomes and business’s ability to invest. This will mean that GDP contracts in Q4 by around 0.5% as well. Given the lag between interest rates rising and the impact of that on the real economy, we’re expecting the recession to last until late 2023.
The big risk is that a severe shift towards growth-damaging austerity measures, such as cutting benefit payments or government investment, will prolong the recession or dampen the recovery (as we saw after the Global Financial Crisis).
However, not all recessions are created equal. We expect a peak-to-trough fall in GDP of around 1.5%. That would be slightly smaller than the early 1990s recession, significantly smaller than the Global Financial Crisis (which had a peak-to-trough drop in GDP of around 6%), and a fraction of the pandemic when GDP fell by 22%!
The big picture is that the economy could be no larger in 2025 than it was in 2019, before the pandemic.
This won’t stop the MPC from speeding up its pace of tightening. Policymakers will need to respond to the inflationary impulse of the government’s large, unfunded fiscal package, as well as the drop in sterling since the central bank’s September meeting. Our base case is for a jumbo hike of 100bps when the MPC next meets in November.