ONS GDP data: UK economy contracts 0.3% in August amid deepening cost-of-living squeeze

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

“A shrinking economy in August was always on the cards when you consider the many challenges the country was facing over the summer as the fallout from the war in Ukraine, soaring food and energy prices and rising borrowing costs took their toll on output. With inflation at a 40-year-high of 9.9% in August and the prospect of even higher energy costs at the time, households and businesses had little choice but to rein in expenditure.

“The decline in output of 0.3% was largely driven by falls in the production and services sectors, which had enjoyed a bumper July filled with major sporting events – a reflection of a rapidly shifting economy as Britain readied itself for a difficult winter with sky-high energy costs and a deepening cost-of-living crisis.

“The Government’s emergency package of state energy support, which included freezing average household energy bills at £2,500 for two years, might have prevented inflation spiralling to highs of 22% in early 2023, but this was quickly forgotten when Chancellor Kwasi Kwarteng delivered his ‘mini-budget’.

“Kwarteng’s raft of tax-cutting measures which were announced with the absence of forecasts and new fiscal rules, spooked the financial markets, triggering a surge in borrowing expectations.

“While the 45p tax rate cut for the highest earners was later reversed in a dramatic Government U-turn, markets still expect the Bank of England to increase interest rates to above 5.5% by the summer next year.

“As a result, the UK is now mired in a cost-of-borrowing crisis with two-and five-year fixed rate mortgages now well past the 6% mark – the highest level in more than a decade – and homeowners with mortgage deals expiring soon facing repayments hundreds of pounds more expensive.

“In such a topsy-turvy environment, with budgets already stretched to the max by much higher food, energy and fuel prices than a year ago and real wages dropping 2.9% between June to August, it’s only natural for households to slash expenditure even more.

“While some employers are dishing out multiple pay rises to retain workers in the face of an inflation peak above 11%, the International Monetary Fund has warned that higher prices will persist longer in Britain than other advanced economies because of Kwarteng’s tax-cutting fiscal plan – averaging 9% next year and ending 2023 at 6.3%, which is higher than every member of the eurozone apart from Slovakia.

“The UK may not be in a recession yet, after the ONS revised its second quarter GDP figures to growth of 0.2% compared to its initial estimate of a 0.1% contraction but that will change going forward. A recession is technically defined as two consecutive quarters of contraction, with some analysts forecasting a deeper recession than expected from the fourth quarter of this year as the double hit of the cost-of-living and cost-of-borrowing crises constrain consumer demand.

“While the IMF expects the UK to be the fastest growing economy in the G7 this year with 3.6% growth as a result of Kwarteng’s fiscal plan, it only expects the country to expand 0.3% in 2023 – one of the lowest rates in the G7 - although the Washington-based lender sees a downturn hitting much of the developed world.

“Households already contending with higher bills should rein in spending where they can and keep a close eye on interest rates, which are widely expected to jump by 1%, or even a staggering 1.25%, at the next MPC meeting on November 3 taking the base rate to 3.5% from the current level of 2.25% with further hikes to come.

“For workers, the worrying thing about a recession is it raises the risk of job loss, and with mortgages becoming increasingly expensive, the wisest personal finance strategy going forward is to buffer your finances by building up an emergency fund of at least six to 12 months of expenses to ensure household finances are prepared for the choppy waters ahead.”