UK economy shrinks in third quarter, raising recession risk

The UK economy unexpectedly shrank in the third quarter, raising the possibility that Britain is already in a recession and fueling bets on the Bank of England pivoting to interest-rate cuts as soon as the spring.

Revised figures Friday showed GDP dropped 0.1 per cent from the second quarter, a downgrade from the zero growth initially estimated. Economists had expected the second estimate to be unchanged.

The Office for National Statistics also downgraded its estimate for the second quarter, saying there was no growth compared to the 0.2 per cent expansion previously thought.

The revision to the third quarter puts the UK at risk of a technical recession “- two quarters of falling GDP “- or an even longer slump. Output fell 0.3 per cent in October on a month-on-month basis, putting the economy on track to shrink in the fourth quarter unless it manages to recover lost ground in November and December.

“The mildest of mild recessions may have begun in the third quarter,” said Ashley Webb, UK economist at Capital Economics. “Looking ahead, the latest activity surveys point to weak GDP growth in the fourth quarter too.”

The figures could increase the pressure on Bank of England Governor Andrew Bailey and his colleagues to abandon their higher-for-longer rhetoric and start cutting rates. Investors responded to the data by adding to their bets on a BOE pivot. They are now almost fully pricing in six quarter-point cuts, with the reductions beginning in May.

Gilts gained at the open, with the 10-year yield slipping one basis point to 3.51 per cent. The pound was little changed.

The downgrade is also bad news for Prime Minister Rishi Sunak as he gears up for an election next year, with his Conservative Party trailing the Labour opposition in opinion polls by around 20 percentage points. Sunak made growing the economy a key pledge earlier this year and urged voters to hold him to account.

“The medium-term outlook for the UK economy is far more optimistic than these numbers suggest,” said Chancellor of the Exchequer Jeremy Hunt. “We’ve seen inflation fall again this week, and the OBR expects the measures in the Autumn Statement, including the largest business tax cut in modern British history and tax cuts for 29 million working people, will deliver the largest boost to potential growth on record.”

There was better news on retail sales, which rose a stronger-than-forecast 1.3 per cent in November from October, separate data show.

Sales rose across the board as consumers took advantage of earlier-than-usual Black Friday promotions and wider discounting. It means retail sales will contribute to GDP in the fourth quarter unless they fall by 0.7 per cent or more in December.

“UK retail sales grew by far more than expected in November, supported by one-off cost-of-living payments and heavy discounting during the Black Friday sales. Still, the bigger picture is one where consumer spending will remain under pressure as higher interest rates eat into household budgets despite wage growth surpassing inflation.” Niraj Shah, Bloomberg Economics.

Currently private-sector economists and the Bank of England expect GDP to be flat this quarter, capping off a lackluster year for the UK economy.

The fall in GDP was caused by the powerhouse services sector, which accounts for four fifths of UK output. Services shrank 0.2 per cent, more than offsetting 0.4 per cent growth in construction and 0.1 per cent growth in production. Within the production sector, manufacturing grew 0.1 per cent.

Later returns showed film production, engineering and design, and telecommunications all performing “a little worse than we initially thought,” said Darren Morgan, ONS director of economic statistics.