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What is a recession and why is the UK in one?

recession Chancellor of the Exchequer JEREMY HUNT is seen outside BBC as he appears in breakfast shows after revealing mini budget
Chancellor Jeremy Hunt previously said he was comfortable with recession if it brings down inflation. (ZUMA Press, ZUMA Press, Inc.)

The UK has fallen into a technical recession, with a sharper decline in gross domestic product (GDP) for October to December 2023 than expected.

It was the second quarterly fall in a row, coming after a decrease of 0.1% in the previous quarter, between July and September.

Across the whole year, GDP was estimated to have increased by 0.1% compared with 2022, while on a monthly basis, Britain ended the year with a 0.1% decline in December.

The latest data means that the UK was the joint-worst performing G7 economy in the final quarter of the year.

"Our initial estimate shows the UK economy contracted in the fourth quarter of 2023. While it has now shrunk for two consecutive quarters, across 2023 as a whole the economy has been broadly flat," said Liz McKewown, ONS director of economic statistics.

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Read more: What is a technical recession and what does it mean for me?

“All the main sectors fell on the quarter, with manufacturing, construction and wholesale being the biggest drags on growth, partially offset by increases in hotels and rentals of vehicles and machinery,"

She added: "The latest data showed that health and education performed less well than initially estimated in both October and November. Early indications suggest they both contracted in December.

"Retail and wholesale were the biggest overall downwards pulls on the economy in December, partially offset by growth in computer programming and manufacturing."

What is a recession?

Usually, when a country’s output is growing, the value of the goods and services it produces — known as its gross domestic product — goes up. But during an economic downturn this value falls.

A recession is a period of negative economic growth for two consecutive quarters. It is when GDP drops for two three-month periods in a row, and comes as a sign that the economy is weakening.

Inflation

Following the updated GDP release, chancellor Jeremy Hunt pinned the recession blame on inflation and high interest rates.

“High inflation is the single biggest barrier to growth which is why halving it has been our top priority. While interest rates are high — so the Bank of England (BoE) can bring inflation down — low growth is not a surprise," he said.

Read more: Bread, meat and biscuits get cheaper as UK food inflation drops

“But there are signs the British economy is turning a corner; forecasters agree that growth will strengthen over the next few years, wages are rising faster than prices, mortgage rates are down and unemployment remains low. Although times are still tough for many families, we must stick to the plan — cutting taxes on work and business to build a stronger economy.”

It comes as inflation in Britain, which measures how prices rise over time, unexpectedly remained unchanged at 4% in January.

The figure from the Office for National Statistics (ONS) was the same as in December and came in below economists' forecasts, including the Bank of England. Economists polled by Reuters expected prices to rise by 4.2% compared to the same month last year.

Keeping prices rising was the energy price cap, which rose in January, bringing up the cost of gas and electricity.

The ONS said monthly prices for food and non-alcoholic beverages fell by 0.4% between December and January, compared with a rise of 0.6% a year ago. Monthly prices for food (excluding non-alcoholic beverages) also fell by 0.4%.

This was the first fall in monthly prices since September 2021, and the largest fall since July 2021.

The drop eases pressure on the Bank of England to keep interest rates higher for longer to bring inflation back down to its 2% target.

Interest rates

On the back of the latest GDP news, money markets have increased their bets of an interest rate cut from Threadneedle Street, pricing in around 78 basis points of cuts this year. This is equivalent to more than three quarter of a point rate cuts, compared with about 70 bps before the figures.

It comes as the BoE left UK interest rates on hold at their current 16-year high of 5.25% for a fourth consecutive time earlier this month.

In its first meeting of the year, members of the monetary policy committee (MPC) voted in a three-way split to leave the key lending rate unchanged.

Read more: What is inflation and what does it mean for you?

The overall move was widely expected by economists, and means that rates have now been held at this level since last August.

It also continues to take some of the pressure off borrowers who have seen costs go up steadily from lows of 0.1% at the end of 2021, to the highest rate since early 2008.

Officials at the UK's central bank had already cautioned that it was “too early” to talk about cutting interest rates, despite a small uptick in inflation in December.

Threadneedle Street said it would keep interest rates “under review”, adding that inflation will hit its target of 2% in the second quarter of this year but then increase again in the second half of this year.

It blamed “the persistence of domestic inflationary pressures”, adding: “CPI inflation is projected to be 2.3% in two years’ time and 1.9% in three years.”

By raising interest rates, the theory is that people spend less, demand goes down and then this should mean inflation drops. But mortgages rates are usually linked to interest rates, meaning those who are not on a fixed-rate mortgage face steep increases to their monthly repayments.

Previously the chancellor has backed interest rate increases being used to calm soaring inflation even if they increase the risk of pushing the UK into recession.

Hunt told Sky News that the "only path to sustainable growth" is to bring down the high prices behind the cost of living crisis.

Asked whether he was comfortable with the BoE doing whatever was needed to bring down inflation, even if that could cause a recession, Hunt said: “Yes, because in the end, inflation is a source of instability.”

“If we want to have prosperity, if we want to grow the economy, if we want to reduce the risk of recession, we have to support the Bank of England in the difficult decisions that they take.

Watch: How does inflation affect interest rates?

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