Short and shallow: Why we shouldn't panic over news of another UK recession

Bank of England likely to come under increasing pressure to bring forward interest rate cuts.

It could well turn out to be the recession that time forgot. The news that Britain’s economy contracted by 0.3 per cent in the final three months of 2023 came as little surprise, though the fall may have been slightly steeper than some had been predicting.

Coupled with the decline of 0.1 per cent in the previous three months it means that the UK entered a technical recession, as defined by two or more quarters in a row of falling output, or gross domestic product (GDP). The last time the economy tumbled into recessionary territory was in the first half of 2020, when the initial pandemic lockdown took its toll.

The latest slump is clearly an unwelcome development when the government is attempting to get the economy back on its feet, spur growth and encourage business investment while getting a grip on inflation and high interest rates. Rishi Sunak has vowed to grow the economy as one of his five key priorities.

Many businesses have fallen victim to the recession, while others have been struggling with higher costs and reduced trade.

The Chancellor, meanwhile, is sticking to his guns, insisting that the underlying picture is one of an economy that is “more resilient than most people predicted”. Jeremy Hunt’s counterpart, shadow chancellor Rachel Reeves, said the Prime Minister’s economic growth pledge has been left “in tatters”.

While the estimates from the Office for National Statistics (ONS) could still be revised up or down in the coming months, the recession of late 2023 is likely to prove one of the shallowest in recent times. It is also likely to be short-lived, with GDP expected to have picked up from the start of 2024. Any recessionary fears also strengthen the case for early interest rate cuts and further tax incentives in the Chancellor’s March Budget.

Sarwar Khawaja, chairman of the executive board at Oxford Business College, said that while “the r word” was inescapable, the latest GDP data was “not as bleak as it seems at first glance”. He said: “The economy grew - albeit by a modest 0.1 per cent - over 2023 as a whole, and while new orders in construction, a good bellwether for wider business confidence, are well down, other indicators suggest sentiment is holding steady.

“So much so that there are hopes that the recession could be brief and shallow. While inflation is proving sticky, the Bank of England will come under increasing pressure to bring forward interest rate cuts, and the prospect of looser monetary policy should support the economy in the coming months.”

Prime Minister Rishi Sunak has vowed to grow the economy as one of his five priorities.

The ONS said output fell 0.1 per cent in December after downwardly-revised growth of 0.2 per cent in November, while the contraction in October was also worse than first thought, at 0.5 per cent against the 0.3 per cent fall initially estimated. Across the year as a whole, the economy grew, but by an anaemic 0.1 per cent, down from 4.6 per cent growth in 2022 and - when stripping out the pandemic-hit plunge seen in 2020 - the weakest expansion since the aftermath of the financial crisis in 2009. The ONS noted that the contraction was broad-based across the economy in the fourth quarter.

Thomas Pugh, UK economist at audit, tax and consulting firm RSM UK, said: “Overall, [this] data reinforces our view that Q4 last year will represent the nadir of a particularly painful period of stagnation for the UK economy. But we are now at a turning point. Interest rate cuts are likely to come in the spring and growth should gradually improve in the first half of this year and pick up further after the summer and into 2025.”

The GDP numbers came just a day after news that the annual rate of inflation had remained unchanged at 4 per cent in January, coming as it did against expectations for another slight increase, to 4.2 per cent, following December’s upturn from 3.9 per cent. Encouragingly, the latest official figures showed that food prices fell last month for the first time in almost two-and-a-half years. While the headline inflation rate remains double the Bank of England’s 2 per cent target, hopes are building that the lack of any new shocks could persuade policymakers to opt for a cut in interest rates in the coming months. Many analysts are forecasting a series of three quarter-point reductions over the course of 2024, which would take the bank base rate down to about 4.5 per cent.

Julian Jessop, economics fellow at the free market think tank, the Institute of Economic Affairs, said: “The key driver of the slump into recession is the increase in interest rates. It is important that the Chancellor avoids doing anything that might reignite inflation and encourage the Bank of England to keep rates higher for longer. But there is room for some well-targeted tax cuts that would both support demand and boost the productive potential of the economy. Nonetheless, the UK’s problems clearly run deep, and a few tweaks to interest rates and tax rates won’t fix them.”

Liz Cameron, chief executive of the Scottish Chambers of Commerce, added: “While this recessionary data is slight, it confirms what our own business research had been saying for all of 2023 - that the economy remained persistently locked in a low growth cycle of stagnation as headwinds continued to weigh heavily on firms. The Chancellor must use the upcoming spring Budget in just a few weeks to set out his government’s plans to help business and the economy to grow. Businesses need long-term certainty through an economic plan that relieves their cost pressures and helps unlock much needed investment.”