ONS GDP data: Economy contracts 0.1% in second quarter as cost-of-living crunch digs in

Alice Haine, Personal Finance Analyst at Bestinvest, the DIY investment platform and coaching service, comments:

“A GDP contraction in the second quarter was always on the cards as the economy - battered by the cost-of-living crisis and the wider global challenges posed by the war in Ukraine - heads towards a recession at the end of the year.

“While a decline of 0.6% in June was lower than expected, it was exacerbated by May’s surprise expansion of 0.4% on the back of the celebrations around the extra Jubilee bank holiday. Despite May’s positive GDP figure, the economy still contracted marginally by 0.1% across the second quarter.

“While the withdrawal of the NHS Test and Trave Covid-19 vaccination services was one of the main drivers behind the contraction, the hit to household finances from runaway inflation as energy and food prices spiralled upwards and fuel also hit record highs in the April to June period must be factored in too.

“There was a 0.2% decrease in real household consumption in the second quarter as many households slashed budgets and dramatically reduced expenditure to ensure their finances hold up not only this summer but also through the long winter months when energy prices are expected to soar even higher.

“Earlier this month, the Bank of England dramatically downgraded its economic outlook as it increased interest rates by the largest margin in 27 years and forecast that inflation will peak at 13.3% by the end of this year, with annual price gains still hovering around the 10% mark in a year's time.

“The big shock, however, was the Central Bank’s year-long recession forecast, with no growth expected for almost two years and unemployment expected to increase from its current 3.8% level by two thirds.

“While the downbeat outlook reflected the ongoing war in Ukraine and cuts in gas supply to Europe, what the BoE could not factor into its assessment was the effect of any tax cuts brought in by whoever wins the Conservative Party leadership race.

“While frontrunner Liz Truss has promised immediate fiscal relief, Rishi Sunak has also pledged extra handouts to combat the energy crisis, as they attempt to outbid each other in the race to No.10.

“But until the winner is in place and the plans are in motion, the Central Bank cannot factor those changes into its forecast. The big question is to what extent the new prime minister will help households handle the extortionate energy bills coming their way. Yes, a £400 support payment will be issued to all in October but that won’t stretch very far.

“With a warning this week from energy consultancy Auxilione that Ofgem could be forced to set the energy price cap at £5,038 per year for the average household in the three months beginning next April, whoever takes the helm will need to act fast if they want to prevent the economy from tanking any further.

“Some consumers are already hurting as bills rise ever higher and will be looking to the Government for more support as they face stark choices, such as prioritising food over heating their homes to avoid hefty bills.

“Worrying about heating may seem ridiculous when we are in the middle of another summer heatwave but even those that that could comfortably meet the household bills in the past will be forced to spend more carefully in the months ahead. In October, when the next Ofgem price cap is expected to go up to an average of £3,582 – the double hit of higher bills and colder temperatures will deliver a quick wake-up call for all, with worse to come next years.

“The only way to prepare for the financial onslaught ahead is to shore up your finances now, by drawing up a budget and slashing spending where possible to create space for the bigger bills to come.

"This could include funnelling money into an easy-access savings account in preparation for the big energy bills to come. With household energy debt hitting an all-time high of £1.3billion – nearly three times higher than it was in September, according to August data from comparison site Uswitch – it shows households are already struggling

“The research also found six million households are already behind on their energy bills by more than £200 with a further eight million bill-payers having no credit balances. This puts up to 14 million households at risk of severe financial hardship this winter.

“Throw higher interest rates, higher mortgage payments and lower savings into the mix and the winter months look increasingly bleak. Hopefully a new leader can deliver some fiscal cheer in time for Christmas to ensure the year ends on a slightly more upbeat note.”