UK GDP: Not the start of the recession…yet

The UK economy showed more resilience than expected in June. Yes, GDP contracted by 0.6% month-on-month (m/m) in June, meaning that output dropped by 0.1% on the quarter. But much of this can be explained by the extra bank holiday in June and fewer coronavirus vaccinations. The UK’s real economy held up reasonably well.

We expect GDP growth to rebound in July and Q3 – so this isn’t the start of the recession. However, that is likely to be the last good news for a while. The huge energy bill increases on the way are likely to tip the economy into a recession that will last roughly a year, and see a peak-to-trough fall in GDP of around 1% to 2%. The big picture is that the economy could be no larger in 2025 than it was in 2019, before the pandemic.

GDP stronger than it looks

June’s drop in GDP was driven by two factors. First, the extra Jubilee bank holiday sent output lower across the economy. Previous one-off national holidays have tended to reduce output by around 2% month-on-month (m/m), so the drop in GDP in June seems like more of a dip. We suspect that the holiday was behind most of the falls in output in the manufacturing (-1.6% m/m) and construction (-1.4% m/m) sectors.

Second, output in the health sector fell by 1.8% m/m in June. This was mainly due to weaker ‘test and trace’ activity and the tailing off of vaccine programmes – hardly something the real economy should be concerned about. Indeed, output in consumer-facing services remained flat.

On a quarterly basis, the drop of 0.1% quarter-over-quarter (q/q) was driven by a reduction in real government expenditure, which reflects lower levels of activity to do with coronavirus, and less consumer spending. This is unlikely to be the last quarterly contraction given the huge squeeze on consumer incomes.

More positively, there was a 3.8% q/q rise in businesses investment. This is cause for celebration, especially as the UK routinely trails behind other developed countries in this area.

What next?

Look for a ‘mechanical bounce back’ in July’s GDP figures. This is because there were only 20 working days in June, compared to 21 in July, so even if output per hour remained the same, output over the month as a whole would still rise because of the extra working day. This means Q2 probably wasn’t the start of a recession, which is defined in the UK as two consecutive quarters of contracting GDP.

However, looking further ahead, the energy price cap is likely to go up by 75% in October and that’s projected to push inflation to 13% in Q4. That will be the point where the economy tips into a recession that will last roughly a year, and see a peak-to-trough fall in GDP of around 1% to 2%.

However, not all recessions are created equal. The Bank of England forecasts that this one will begin in Q4 and last all the way through 2023, putting it on a par with the early 1990s recession. But it would still be significantly smaller than the Global Financial Crisis, which had a peak-to-trough drop in GDP of around 6%, and only a fraction of what we saw during 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.

Policy takeaway

The real economy seems to be holding up reasonably well, so another interest rate rise in September seems likely. Expect interest rates to reach 2.25% by the end of the year, and peak at around 2.75% by the middle of 2023 before the recession forces the Bank to pause its tightening cycle.