UK GDP falls 0.6% in September and 0.2% in Q3: what this means for household finances and investments

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

“A contracting economy in September and the third quarter was to be expected when you consider the many headwinds battering the economy - from the war in Ukraine to persistently high prices, rapidly rising interest rates, falling real incomes and a cost-of-living crisis crippling household expenditure.

“With inflation at a 40-year-high of 10.1% in September and expected to peak at around 11% in the fourth quarter, many households and businesses had little choice – either they drastically reduce expenditure or risk falling into financial difficulty.

“September was a tricky month for the economy with at least half of the month’s fall in output constrained further by a key moment in history - the death of Queen Elizabeth II, with the mourning period and extra bank holiday suppressing activity as companies and individuals cancelled events to pay their respects.

“The start of September was also a crunch point for the cost-of-living crisis as the country was facing the prospect of gas and electricity bills rising 80% just a month later and inflation potentially on track to hit the unimaginable level of 22% at the start of 2023.

“While Liz Truss, the new prime minister at the time, averted this crisis with her energy price guarantee - which capped average annual energy bills at £2,500 for two years and gave businesses similar support for a shorter time span - this was followed just a couple of weeks later by former Chancellor Kwasi Kwarteng’s disastrous mini budget.

“The fallout from Kwarteng’s unfunded tax cuts, made in the absence of forecasts, caused chaos in the bond markets and a surge in borrowing costs – undoing all the good from the emergency energy proposal.

“The political and financial environment may have stabilised for now, but new PM Rishi Sunak and Chancellor Jeremy Hunt face a difficult dilemma at next week’s Budget, needing to walk a line between reassuring the bond markets and finding spending cuts and tax rises that will drive a deeper recession which could, in turn, hurt tax receipts.

“Meanwhile, the quarterly drop of 0.2% potentially marks the state of the recession with the three-month period a reflection of a rapidly shifting economy. July’s packed calendar of major sporting events hosted by UK, including the Women’s Euro Championship and Commonwealth Games, slightly offset the late summer slump following the death of the Queen and as Britain readied itself for a difficult winter with sky-high energy costs and a deepening cost-of-living crisis.

“The road from here, however, is littered with potholes, despite most of Kwarteng’s tax-cutting measures now consigned to the history books. The Bank of England thinks the UK entered a recession this summer that will last well into 2024, with unemployment set to rise significantly to 6.4% in the fourth quarter of 2025 from the current level of 3.5%. However, this assessment was made prior to the upcoming Budget which may worsen the outlook further given the potential scale of fiscal tightening being considered.

“For households already struggling financially, the possibility of losing their job adds another level of fear to their financial security and that’s without factoring in the raft of tax rises and spending cuts expected next week when Chancellor Jeremy Hunt unveils his Autumn Statement next week.

“As we head into winter and a potentially long, drawn-out recession, consumers are right to be fearful of bleak times ahead. Food inflation rose by 14.6% on the year to September, while those remortgaging now are facing monthly repayments hundreds of pounds higher.

“A scaled-back Christmas will be crucial for those whose budgets are already squeezed to the max. But while trimming back any unnecessary frivolity will help, savings and long-term investments should not be neglected either as finances need to remain as robust as possible not just for the next year or two but long after this recession is over.

“Many Britons have already taken note with households depositing an additional £8.1 billion with banks and building societies in September as they bolster finances for difficult times ahead. Stashing an emergency fund in the highest possible easy-access account you can find is a no-brainer when you consider rates are now at their highest level in well over a decade, but don’t keep all your money in cash.

“If you don’t need it for five years or more, regular investing no matter what the price, allows investors to take advantage of the lows as well as the highs and ensure they don’t leave a hole in their retirement pot. Yes, markets are volatile and could still go down from here, but with main indices at a lower price point today than the start of the year, drip-feeding money in now when equity prices are cheaper should pay off over the long term.

“There is some Christmas cheer in all of this economic gloom: inflation is expected to fall sharply from the middle of next year and while further interest rate rises are still on their way, they won’t hit the 5.25% peak expected by the financial markets at one point. Instead, they should peak at about 4.75% next year which could mean consumers are in the eye of the financial storm now with calmer times ahead. But with the property market on the slide and a long recession ahead, now is not the time to get complacent about your money.”

Jason Hollands, Managing Director of Bestinvest, said: “Given the formidable headwinds facing the UK economy, we think investors should remain cautious towards UK mid and small caps stocks which are typically more domestically focused. In particular, the outlook is going to be very tough for businesses that are sensitive to discretionary spending – including much of the retail sector, as well as hospitality and leisure stocks. 

“The property sector is also very vulnerable, with the prospect of both a slump in the housing market as borrowing costs surge and the likelihood of rising vacancies in the commercial property market as businesses go bust or retrench. While banks have benefited from margin expansion as interest rates have been hiked, a prolonged recession is also going to mean a rise in bad loans.

“We expect the more resilient parts of the market in this tough climate to be staples – businesses that make everyday stuff that people will continue to need whatever the state of the economy, healthcare and utilities. 

“The best place to focus right now is on the large and highly international companies found in the FTSE 100, which generate around three quarters of their revenues outside of the UK. The good news is that this part of the market is incredibly cheap compared to longer-term trends and at the lowest level against global equities in three decades.

“With FTSE 100 earnings forecasts holding up relatively well and upgrades exceeding other major markets this year, there is a lot of upside potential accompanied by the highest level of dividend yield among developed markets globally.”