UK on the Brink of Recession After Economy Contracts by 0.2% in the Third Quarter

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  • The U.K. economy contracted by 0.2% in the third quarter of 2022, signaling what could be the start of a long recession.
  • However, the third-quarter contraction was less than the -0.5% expected by analysts.
  • The Bank of England last week forecast the country's longest recession since records began.

LONDON — The U.K. economy contracted by 0.2% in the third quarter of 2022, signaling what could be the start of a long recession.

The preliminary estimate indicates that the economy performed better than expected in the third quarter, despite the downturn. Economists had projected a contraction of 0.5%, according to Refinitiv.

The contraction does not yet represent a technical recession — characterized by two straight quarters of negative growth — after the second quarter's 0.1% contraction was revised up to a 0.2% increase.

"In output terms, there was a slowing on the quarter for the services, production and construction industries; the services sector slowed to flat output on the quarter driven by a fall in consumer-facing services, while the production sector fell by 1.5% in Quarter 3 2022, including falls in all 13 sub-sectors of the manufacturing sector," the Office for National Statistics said in its report Friday.

The Bank of England last week forecast the country's longest recession since records began, suggesting the downturn that began in the third quarter will likely last deep into 2024 and send unemployment to 6.5% over the next two years.

The country faces a historic cost of living crisis, fueled by a squeeze on real incomes from surging energy and tradable goods prices. The central bank recently imposed its largest hike to interest rates since 1989 as policymakers attempt to tame double-digit inflation.

The ONS said the level of quarterly GDP in the third quarter was 0.4% below its pre-Covid level in the final quarter of 2019. Meanwhile, the figures for September, during which U.K. GDP fell by 0.6%, were affected by the public holiday for the state funeral of Queen Elizabeth II.

U.K. Finance Minister Jeremy Hunt will next week announce a new fiscal policy agenda, which is expected to include substantial tax rises and spending cuts. Prime Minister Rishi Sunak has warned that "difficult decisions" will need to be made in order to stabilize the country's economy.

"While some headline inflation numbers may begin to look better from here on, we expect prices to remain elevated for some time, adding more pressures on demand," said George Lagarias, chief economist at Mazars.

"Should next week's budget prove indeed 'difficult' for taxpayers, as expected, consumption will probably be further suppressed, and the Bank of England should begin to ponder the impact of a demand shock on the economy."

Dutch bank ING sees a cumulative hit to U.K. GDP of 2% by the middle of 2023, which would be comparable to the country's recession in the 1990s.

ING Developed Markets Economist James Smith said the bank was penciling in a 0.3% contraction in economic activity in the fourth quarter, as consumer spending falls away, which would cement the technical recession.

"As the winter wears on, we also expect to see more strain emerge in manufacturing and construction – both of these sectors suffered noticeably during the 1990s and 2008 recession," Smith said.

"The fall in manufacturing new orders, linked to falling global consumer demand for goods and rising inventory levels, as well as higher energy costs, point to lower production by early 2023. Likewise, the sharp rise in mortgage rates, and the very early signs of house price declines, point to weaker building activity through next year."

ING expects the Bank of England's interest rate hiking path to peak at around 4%, but Smith noted that a lot will depend on next week's fiscal announcements.

"A lot of the focus understandably will be on how the Chancellor closes the forecasted fiscal deficit in 2026/27. But above all, we'll be looking for details on how the government will make its energy support less generous from April, something which has the greatest scope to reshape the 2023 outlook," he said.

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