UK economy shrinks by 0.3% as market volatility threatens ‘deep’ recession

The economy contracted unexpectedly in August as a modest rise in construction output was offset by falls in manufacturing and services, according to the latest data from the Office for National Statistics.

Month-on-month gross domestic product (GDP) fell by 0.3 per cent, resuming its downward trend after a brief return to growth over summer. City economists had forecast a flat reading of zero.

GDP growth in July was also revised down to 0.1 per cent from a previous estimate of 0.2 per cent, with the economy was now believed to be back at its size just before the coronavirus pandemic struck, having previously been estimated at 1.1 per cent above it.

The latest data means the economy is likely to contract overall in the third quarter, with the ONS confirming there would need to be growth of more than 1 per cent in September to avert a quarterly decline.

It comes amid fears that the UK is heading for a recession as the cost-of-living crisis takes its toll on households and businesses.

Grant Fitzner, chief economist at the Office for National Statistics, said: “Oil and gas production fell as more scheduled North Sea summer maintenance took place than usual. Notable decreases were also seen across much of manufacturing.”

Fitzner added that a drop in the number of hospital consultations and operations led to a fall in output of health services, while sporting events and consumer-facing services like retail and hotels also struggled to maintain sales. “On the positive side, these falls were partially offset by stronger than usual summer performance from many professional services such as lawyers, accountants and architects,” he said.

A modest rise in construction output was not enough to offset declines in production and in the UK’s dominant services sector. Output dropped by 5 per cent in the arts, entertainment and recreation sectors amid the worst squeeze on household incomes in decades. Meanwhile, a global downturn in the trade of goods, driven by a surge in the price of supplies and ongoing disruptions, has taken its toll on manufacturing output, which fell by 1.6 per cent on the month.

Economists have warned that the additional bank holiday in September for the Queen’s funeral, combined with the impact on consumer sentiment of the ten-day national mourning period, could weigh on business figures for the third quarter.

Fears continue to grow about the health of the economy as soaring inflation, fuelled by a global surge in energy prices, takes a toll on household finances. Inflation hit 9.9 per cent, according to the latest reading for August.

Kwasi Kwarteng, the chancellor, said: “Countries around the world are facing challenges right now, particularly as a result of high energy prices driven by Putin’s barbaric action in Ukraine. That is why this government acted quickly to put in place a comprehensive plan to protect families and businesses from soaring energy bills this winter.

“Our growth plan will address the challenges that we face with ambitious supply-side reforms and tax cuts, which will grow our economy, create more well-paid, skilled jobs and in turn raise living standards for everyone.”

Samuel Tombs, chief economist at Pantheon Macroeconomics, the consultancy, said the UK is “one big step closer to a recession.”

GDP is expected to have fallen by 0.3 per cent in September, owing to the extra bank holiday for the late Queen’s funeral, Tombs said. “GDP likely will continue to decline over the coming months, now that around one-third of households no longer have meaningful savings left, and the 30 per cent that have a mortgage reduce expenditure in response to, or in advance of, a sharp rise in their monthly loan payments.”

He predicted that the UK will technically enter a recession in the final quarter of the year, with the economy shrinking by 1.5 per cent over 2023. “The combination of the protracted hit to real incomes from mortgage refinancing, the usual lags between changes in corporate sentiment and spending decisions, and the constraints macro policymakers now face suggests that the recession won’t end until late 2023 at the earliest,” Tombs said.

Yael Selfin, chief economist at KMPG UK, said: “The ongoing squeeze on household finances continues to weigh on growth, and is likely to have caused the UK economy to enter a technical recession from the third quarter of this year.

“The prospect of the Bank of England raising base interest rates higher and worries about a shaky housing market could see GDP falling by as much as 1.6 per cent in 2023.

Martin Beck, chief economic adviser to the EY Item Club, said the UK was on course for a “substantial fall” in GDP overall in the third quarter.

He said: “The EY Item Club expects a large month-on-month fall in GDP in September due, in part, to the extra bank holiday.