Over 50% chance of recession as economy slows

25 July 2008

The growth of the UK economy has slowed sharply, mainly as a result of the significant slowdown in the construction industry, triggering renewed predictions of a recession.

The Office of National Statistics (ONS) reports that gross domestic product (GDP) – the official measure used to gauge the health of the economy – grew by just 0.2% between April and June this year, the lowest period of growth for three years.

To put this figure into context, between April 2007 and June this year, the economy grew by 1.6%. Between the same months in 2006 and 2007, the growth rate was a much healthier 2.3%.

The impact of the credit crunch on the construction industry is one of the main drivers for GDP slowing so significantly, despite the sector only accounting for 6% of the total economy, according to the ONS. Building activity fell by 0.7% during the period, compared with an increase of 0.4% in the previous quarter, largely because demand for new residential properties has fallen by the wayside in light of the lack of available and cheap mortgage credit.

Economic growth is mainly driven by services; as these sectors have taken a credit crunch-induced hit the overall economy has suffered. Growth in the leisure sector, including hotels and restaurants, for example, slowed during the second quarter of 2008, although it managed to avoid falling into negative growth largely as a result of strong sales on the high street.

However, retail spending has taken a hit in more recent times putting a question mark over how long positive growth will be reported in this area.

Peter Newland, an economist at Lehman Brothers, says the figures are not as bad as he had predicted but warns there is worse to come as the construction sector continues to slow. “We continue to expect negative GDP growth over the next three quarters – therefore, there is a greater than 50% probability of a recession this year,” he adds.

A recession is defined as two quarters of negative growth.

In a speech last night, Charles Bean, deputy governor of the Bank of England and a member of the Monetary Policy Committee (MPC) responsible for setting interest rates, said ONS data did not provide a “precise picture” of the economy.

Bean, who last month voted for an interest rate freeze, added that the slowing economy and rising inflation made the business of setting interest rates tricky, especially as all the data points towards both these issues deteriorating in the near-term. Last month's vote saw a three-way split, with the first vote for an interest rate rise in 12 months, suggesting the MPC is divided over where rates should be set.

Non-MPC economists also offer different opinions on whether inflation or the slowing economy should take priority. Meanwhile, the housing sector continues to call for interest rate cuts to boost mortgage lending.

But Arek Ohanissian, an economist at the Centre for Economics and Business Research, says that just because the UK economy is performing "well below capacity" doesn't mean interest rate cuts will be immediate.

"[The] news of continued slowing economic activity foreshadows easing inflationary pressures. With current inflation well above the Bank of England target levels, there is little scope at the moment for the MPC to lower interest rates in order to stimulate the economy," he explains. "Assuming commodity price inflation starts to slow in the second half of 2008, there will be scope - indeed the need - for a cut in early 2009."

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