14 December 2023
The 0.3% month-on-month (m/m) contraction in GDP in October, coming on the back of flatlining growth in Q3, has our recession warning indicators flashing red. Indeed, there is a significant risk that the UK has now slipped into a recession. However, growth should pick up over the rest of the quarter as a sharp fall in inflation, strong wage growth and government transfers to low-income households give consumer spending a boost. As a result, we expect Q4 to look more like a repeat of Q3 rather than the start of a recession.
In any case, the big picture is still one of a stagnating economy. We doubt growth will materially pick up until towards the end of next year, meaning that the spectre of recession will hang over the UK economy for a long time yet.
The weaker-than-expected economy probably won’t have much of an impact on the Monetary Policy Committee’s (MPC) decision tomorrow. Even though a contracting economy lessons the need to hold interest rates higher for longer, it is still far too early for the MPC to be considering interest rate cuts.
Behind the data
Worryingly, the decline in GDP was broad based, with industrial production falling by 0.8%, construction output dropping by 0.5% and services output falling by 0.2%. Admittedly, the drop in construction output and the 0.1% decline in output across consumer-facing sectors likely can be attributed to bad weather, only five other Octobers since 1836 have seen higher levels of monthly rainfall. The ONS also noted that it had received comments from consumer services firms that demand was lower than usual as a portion of the half-term holidays in some areas fell in November this year.
However, GDP also was supported by some unsustainable sources; output in the health sector increased by 0.4% primarily due to the acceleration of the rollout of coronavirus booster jabs to the over 65s.
We now expect the economy to flatline in Q4, that would mean continued stagnation rather than a recession but there are still significant risks.
About half the impact of the Bank of England’s actions to date is still to hit the economy, the jobs market is cooling, while both excess savings and fiscal support are dwindling. In short, the line between stagnation and contraction will remain a fine one in coming quarters. However, our base case is still that GDP rises gradually into 2024. Prices now are rising substantially less quickly than wages, and households’ disposable incomes will be squeezed only gently by higher interest rates—at least in aggregate—because the value of their bank deposits is now only slightly smaller than the value of their debt. Accordingly, households' real disposable income looks set to rise over coming quarters, albeit sluggishly.
Meanwhile, confidence among both households and businesses has recovered materially over the last six months now that the energy price shock is in the rear-view mirror and the Bank Rate has probably peaked. Granted, there are plenty of downside risks, including the possibility that firms belatedly reduce employment in a bid to cut costs, and a renewed energy price shock in response to geopolitical developments. But our base case remains that the economy continues to muddle through, with GDP rising in Q4, meaning a recession would be avoided, and continuing to grow through 2024.