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UK economy shrinks as stagflation looms

A customer pays for his fruit and vegetables with a ten pound sterling note, at a trader's market stall in London on May 12, 2022. - Britain's economy shrank in March on fallout from soaring inflation, increasing the prospect of the country falling into recession. Official first-quarter data on Thursday showed that following solid output in January, the UK economy posted zero growth the following month and contracted by 0.1 percent in March. (Photo by JUSTIN TALLIS / AFP) (Photo by JUSTIN TALLIS/AFP via Getty Images)
The UK economy shrank in the second quarter. Photo: Justin Tallis/AFP via Getty

Britain's economy contracted between April and June as a decline across all sectors raises fears of stagflation.

Gross domestic product (GDP) shrank 0.1% in the period, compared to a 0.8% growth in the first quarter, according to the Office for National Statistics (ONS).

On a quarterly basis, output fell for the first time since last year when a stringent COVID lockdown shuttered industries, but still below forecasts as economists polled by Reuters predicted a 1.3% decline.

GDP contracted 0.6% in June alone, from a 0.4% — revised down from 0.5% — growth in May. That marked the worst monthly drop since January 2021.

Read more: What is stagflation and can it lead to a recession?

Although June's decline reflected two lost work days from the Queen’s platinum jubilee and an extra working day in May, the ONS said the celebrations had "little impact on the quarterly estimates".

Health was said to be the main contributor, with services output down 0.4% in Q2 and 0.5% in June as test and trace and vaccine programmes were phased out. Human and health services fell 5.4%.

"Health was the biggest reason the economy contracted as both the test and trace and vaccine programs were wound down, while many retailers also had a tough quarter," Darren Morgan, the director of economic statistics at the ONS said. "These were partially offset by growth in hotels, bars, hairdressers and outdoor events."

Production came out of the quarter looking intact despite rising costs. But fell by 0.9% in June, following an increase of 1.3% in May, mainly due to a 1.6% fall in manufacturing.

Construction declined for the first time in seven months, down 1.4% in June.

Both economists and the Bank of England (BoE) expect the economy to grow in the current quarter, before sliding into recession later this year.

Yael Selfin, chief economist at KPMG UK, said: "While we see increasing signs of underlying weakness in the economy, we expect a more severe downturn to take place only from towards the end of this year."

Read more: Bank of England announces biggest interest rate hike in 27 years

However, analysts at the National Institute of Economic and Social Research believe the economy has already tipped into a recession.

"It now looks like the UK economy entered a recession in the second quarter of this year as GDP fell by 0.1%, and we expect output to continue falling over the next three quarters," professor Stephen Millard, deputy director for macroeconomic modelling and forecasting, NIESR, said.

The economic think tank forecast GDP in the third quarter to contract by another 0.1%, with growth likely to slow further as inflation drags on consumer demand.

UK economy forecast. Chart: National Institute of Economic and Social Research
UK economy forecast. Chart: National Institute of Economic and Social Research

Chancellor of the exchequer, Nadhim Zahawi, said: "Our economy showed incredible resilience following the pandemic and I am confident we can pull through these global challenges again.

“I know that times are tough and people will be concerned about rising prices and slowing growth, and that's why I'm determined to work with the Bank of England to get inflation under control and grow the economy."

Read more: UK inflation hits 9.4% as prices rise at fastest rate for 40 years

It comes as the UK economy has recently run into the biggest headwinds since the 1970s.

Higher prices and collapsing real pay — made worse by rising taxes, have led to a decline in household consumption amid the cost of living crisis and made the prospect of stagflation a reality.

Stagflation is a lethal combination of weak or slow growth (stagnation) and high inflation.

Inflation hit a fresh 40-year high of 9.4% in June, nearly five times the Bank’s 2% target, with everything from the price of food to fuel going up, and real wages adjusted for inflation are now falling at the fastest pace in 21 years.

Household incomes will be further squeezed by rising energy bills that are forecast to top £4,200 in January and rise as much as £5,000, plunging millions into debt.

Energy bills.
Energy bills. Chart: Yahoo

Some experts cautioned the numbers solidified the "bleak outlook" for the economy and the new occupant of Downing Street should "provide targeted support".

"The economy has started a difficult period on a weak footing," James Smith, research director at the Resolution Foundation, said. "The first priority for the new prime minister will be to provide further targeted support to low-and-middle income households who will be worst affected by the stagflation that already seems to be taking hold."

Read more: UK workers suffer record drop in real terms pay

In its August meeting, Threadneedle Street predicted a five-quarter long recession from the end of the year, lasting into 2024.

Nevertheless, the MPC raised its key rate by 50 basis points to 1.75% from 0.1% in December 2021 — its biggest in 27 years in a bid to stem surging inflation, which is on track to reach 13.1% later this year.

On Tuesday, the central bank's deputy governor Dave Ramsden signalled that it's likely to continue hiking rates to ensure inflation doesn't become embedded despite the risks to growth.

Watch: What is a recession and how do we spot one?