How will recession affect the UK?

Inflation set to hit 13% by end of year as UK on course for recession, warns Bank of England

Capping energy prices should help businesses by containing inflation
(Image credit: Daniel Harvey Gonzalez/In Pictures via Getty Images)

The Bank of England has warned that the UK is expected to face its longest recession since the global financial crisis.

In its sixth consecutive increase, the Bank yesterday raised interest rates by 50 basis points to 1.75%, the single largest rise since 1995. In its Monetary Policy Summary for August, it said GDP growth is “slowing”, and the latest gas price rises have led “to another significant deterioration in the outlook for activity” in the UK and Europe.

The UK is expected to experience a recession in the final months of the year, as inflation rises above 13%. Households’ post-tax income will “fall sharply in 2022 and 2023, while consumption growth turns negative”, the report said.

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Governor of the Bank of England Andrew Bailey told BBC Radio 4’s Today programme that the “real risk” it is responding to “is that inflation becomes embedded and it doesn’t come down in the way that we would otherwise expect”.

Andrew Sentance, a member of the Bank’s rates-setting committee during the 2008 financial crisis, told BBC Breakfast that the UK is heading for a few years in which “household incomes in real terms are squeezed more severely than we’ve seen in other times since the Second World War”.

What could tip the economy into full recession?

“Multiple factors in play have contributed to the current financial crisis facing the UK,” said Unbiased. “In isolation, they are big challenges but not a disaster. However, a combination of the successive lockdowns in the UK slowing down the economy, along with Russia’s invasion of Ukraine damaging the international market price of gas and oil, mean that the current volatile climate could be set to take another downward turn.”

“The data chimes with widespread warnings that the economy faces a prolonged period of low growth, caused by a cost of living crisis that is only forecast to intensify in the months ahead as energy bills rise to stoke inflation further,” reported Sky News.

City A.M. said: “Firms have retrenched in response to Russia’s invasion of Ukraine, high inflation and ongoing supply chain disruption souring the trading environment, dampening the UK’s growth prospects.” The spike in energy prices as a result of Russia’s restrictions on gas “will exacerbate the fall in real incomes for UK households”, the Bank said yesterday.

Consumers are rapidly reducing their spending in the face of a “once in a generation” cost-of-living squeeze, George Lagarias, chief economist at accountancy firm Mazars, told The Guardian.

“For an economy where consumption is so central, the signs going forward are disconcerting. Technically, we may not yet be in a recession, but for many consumers it certainly feels like one.”

What would a recession mean for the country?

Two successive quarters of decline in gross domestic product (GDP) may sound abstract, but a recession has real-life consequences on everything from job prospects and housing to investments.

“Businesses are likely to try and save money during a recession, meaning jobs could be lost, and with spiralling inflation and energy price hikes, wages may be unable to cover the cost of everyday essentials,” said Unbiased.

The global financial crisis of 2008 resulted in UK unemployment levels reaching 10%. However, “no one can predict the severity or the length of [a recession], making it difficult to outline the tangible impact on UK workers”, said the financial advice site.

Forbes reported that with more people unable to pay their bills during a recession, “lenders tighten standards for mortgages, car loans and other types of financing”. This means you may need a better credit score or a larger down payment to qualify for a loan than would be the case during more normal economic times.

Investments in assets such as stocks, bonds and property can lose value in a recession, cutting income and savings, and denting retirement funds too, it added.

As well as the effect on lower-skilled and lower-paid workers, recessions “also impact young people disproportionately, as we saw from the recession in 2008”, said HuffPost UK.

Are there any positives?

“There are arguments that recessions are part and parcel of the economic cycle,” said the i news site. “They can lead to a clearing out, or what some economists call a reset or ‘correction’.”

This can have knock-on positive effects for some people or sectors. High inflation, for example, such as that seen in the early 1980s, usually leads to higher interest rates, which is good for people with savings.

The recession of the early 1990s, meanwhile, led to lower house prices and interest rates, allowing Generation X and younger Babyboomers to get on the property ladder.

What about the rest of the world?

The risk of the US and Europe “sliding into recession” has “picked up sharply” according to economists who spoke to the Financial Times ahead of the G7 summit in Bavaria this weekend.

Holger Schmieding, chief economist at Berenberg Bank, told the paper that the balance had now “tipped” in favour of an economic contraction next year in the US and Europe, arguing that “what used to be a rising risk has now turned into the base case”.

The FT said that economists had become “increasingly pessimistic” over the chances of a recession, following the Federal Reserve’s decision to increase interest rates to counter “soaring” inflation, and as concerns mount over Europe’s gas supply in the coming winter. The International Energy Agency warned this week that Europe must plan now for winter without any Russian gas exports.

“US recession risks are uncomfortably high and rising,” said Mark Zandi, chief economist of Moody’s Analytics, who spoke to the paper. “I would put them at 40 per cent in the next 12 months, and more or less even odds over the next 24.” Zandi added that Europe was in an even worse situation.

“To avoid recession, the global economy needs a bit of luck and for the economic fallout from the coronavirus pandemic and Russian aggression to wind down quickly, along with some deft policymaking by the Fed and other central banks,” he said.

How long will it last?

The Bank has set off “the most piercing of warning sirens”, said the BBC’s economics editor, Faisal Islam. “The big shock” is its prediction that a recession could last “as long as the great financial crisis" and be "as deep as that seen in the early 1990s”.

If global wholesale energy costs remain as they are currently, then the recession is expected to last the whole of next year, “with inflation barely below 10% even in a year’s time”. And with the Tory leadership contest still underway, Islam explained that this “is the sort of forecast that in other circumstances might have prompted an immediate emergency Budget”, but might instead “upend all the plans” the contenders have announced during their campaigns.

With the UK economy expected to shrink for more than a year, Islam described this as “a proper full fat recession”, and a “textbook example” of stagflation.

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