Economy
The UK economy is sliding into recession and Europe is set to follow
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The UK economy shrank in the third quarter, signaling the start of a recession that is likely to hit Europe next.
UK GDP fell 0.2% between July and September, ending five consecutive quarters of growth, the Office for National Statistics said on Friday.
The United Kingdom is the only G7 economy to have contracted in the third quarter and is now 0.4% smaller than it was at the end of 2019, before the coronavirus pandemic began, according to the ONS.
Isabel Infantes/AFP/Getty Images
“The quarterly fall was driven by manufacturing, which saw widespread declines across most industries. Services were flat overall, but consumer-facing industries fared badly, with a notable fall in retail,” ONS director of economic statistics Darren Morgan said in a statement.
The extra bank holiday for Queen Elizabeth II’s funeral on September 19 also played a role, as some businesses closed or adjusted their operations that day, the ONS said. GDP fell by 0.6% in September.
However, the decline in GDP reflects a slowdown in the economy more broadly. Household incomes are being squeezed by decades high inflation, interest rates are rising and business and consumer confidence is weakening.
“Lower consumer spending appetite is likely to help push GDP into a second-straight contraction during the fourth quarter,” James Smith, developed markets economist at ING, said in a note on Friday.
Recession stalks Europe
The Bank of England warned last week that the UK economy could experience its longest recession since the 1940s. And the third quarter contraction contrasts with expansion of 0.2% in France and Germany, and growth of 0.5% in Italy.
But the picture in Europe is also changing.
The European Commission warned Friday that high inflation and rising interest rates are likely to tip the euro zone into recession in the fourth quarter. It now expects inflation to peak at the end of the year at a rate of 8.5%.
“As inflation keeps cutting into households’ disposable incomes, the contraction of economic activity is set to continue in the first quarter of 2023,” the Commission said in a statement.
Still, the Commission expects GDP growth in the euro area to remain positive next year and in 2024. By contrast, the Bank of England forecast last week that the third quarter would be the start of a recession lasting two years in the United Kingdom.
That would be the longest since World War II and eclipse the downturn that followed the 2008 global financial crisis, though the central bank said that any declines in GDP heading into 2024 would likely be relatively small.
Friday’s GDP figures “solidify the picture that the economy is moving towards recession, if not already in one,” David Bharier, head of research at the British Chambers of Commerce said in a statement.
Weak economic growth piles pressure on the UK government as it tries to restore credibility with investors following a run on the pound and a bond market crash in September, triggered by former Prime Minister Liz Truss’ plan to slash taxes while boosting spending and borrowing.
Finance Minister Jeremy Hunt reversed most of her plans in his first few days on the job, and is expected to announce hefty tax rises and spending cuts next week in a bid to reduce debt in the medium term.
Responding to the latest GDP figures, Hunt said: “I am under no illusion that there is a tough road ahead — one which will require extremely difficult decisions to restore confidence and economic stability. But to achieve long-term, sustainable growth, we need to grip inflation, balance the books and get debt falling. There is no other way.”
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Bank of Canada governor Tiff Macklem says that although a slowing economy may not seem like a good thing, it is when the economy is overheated.
Speaking in Quebec City on Tuesday, Macklem said that higher interest rates are working to cool the economy as elevated borrowing costs are constraining spending on big-ticket items such as vehicles, furniture and appliances.
As demand for goods and services falls, Macklem says the economy will continue to slow.
“That doesn’t sound like a good thing, but when the economy is overheated, it is,” he said.
In addition to global events, the overheated domestic economy pushed up prices rapidly, he said.
To slow the economy domestically, the Bank of Canada has embarked on one of the fastest monetary policy tightening cycles in its history. It has hiked its key interest rate eight consecutive times since March, bringing it from near-zero to 4.5 per cent.
However, last month, the Bank of Canada said it will take a “conditional” pause to assess the effects of higher interest rates on the economy.
“Typically, we don’t see the full effects of changes in our overnight rate for 18 to 24 months,” Macklem said on Tuesday.
“In other words, we shouldn’t keep raising rates until inflation is back to two per cent.”
However, the governor said the Bank of Canada will be ready to raise rates further if inflation proves to be more stubborn than expected.
The Bank of Canada is raising interest rates again, bumping it to 4.5 per cent. This marks the eighth increase in less than a year, leaving some homeowners scrambling to keep their mortgages.
As gas prices have fallen and supply chains have improved, inflation in Canada has slowed since peaking at 8.1 per cent in the summer. Macklem called this a “welcome development,” but stressed inflation is still too high.
“If new data are broadly in line with our forecast and inflation comes down as predicted, then we won’t need to raise rates further,” Macklem said.
For inflation to get back to two per cent, Macklem said wage growth will have to slow, along with other prices.
Wage gains lagging inflation
Wages have been growing rapidly for months but continue to lag the rate of inflation. In December, wages were up 5.1 per cent.
Though annual inflation is still at decades-high levels, economists have been encouraged by a more noticeable slowdown in price growth over recent months.
The Bank of Canada forecasts the annual inflation rate will fall to three per cent by mid-year and to two per cent in 2024.
Royce Mendes, an economist with Desjardins, said that Macklem is crossing his fingers that the rate hikes he has implemented so far will be enough to get it done.
“The head of the Bank of Canada seems quite comfortable sitting on the sidelines even as his U.S. counterpart will be discussing the need for further monetary tightening south of the border,” Mendes said.
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