UK economy contracts as households cut spending

The UK economy contracted in the second quarter, with households cutting spending as the cost of living crisis began to bite and health sector output falling as Covid cases and testing declined.

Gross domestic product, the measure of the quantity of goods and services produced, fell 0.1 per cent in the second quarter of the year after rising 0.7 per cent in the previous quarter.

A temporary recovery is expected in the third quarter before the UK slides into recession over the winter as further rises in energy prices squeeze household incomes and hit spending.

The decline was sharper at the end of the quarter with GDP falling 0.6 per cent in June, but this drop reflected two lost work days from the Queen’s platinum jubilee. The Office for National Statistics, however, said the celebrations had “little impact on the quarterly estimates” and the drop in GDP reflected economic growth grinding to a halt.

Overall, the figures on Friday were close to those expected by economists and the Bank of England.

Yael Selfin, chief UK economist at KPMG, said the end of Test and Trace was significant in the second quarter decline in output and this was temporary, but weakness could be seen across the economy.

“Households are already bruised by rising inflation, which is putting a squeeze on real incomes, while rising interest rates are making servicing mortgages less affordable. The expected rise in Ofgem’s utility tariff cap this autumn could be the final straw before the UK enters a consumer-driven downturn,” she said.

The UK economy performed better than the US in the second quarter, but worse than the other G7 economies of Germany, France, Italy and Canada, which saw greater bouncebacks from the pandemic in the second quarter.

Nadhim Zahawi, the chancellor, said: “I know that times are tough and people will be concerned about rising prices and slowing growth, and that’s why I’m determined to work with the Bank of England to get inflation under control and grow the economy.”

Some economists were more gloomy and thought the decline in GDP already marked the start of a recession. Stephen Millard, deputy director of the National Institute of Economic and Social Research, said: “It now looks like the UK economy entered a recession [because] we expect output to continue falling over the next three quarters.”

The details of the second-quarter figures showed households already feeling the pinch, with consumption down 0.2 per cent, offset by some good news from business investment, which rose 3.8 per cent. Business investment has been erratic in recent quarters and was still 6 per cent lower than pre-pandemic levels.

Trade performance was again poor with another record trade deficit, excluding precious metals. Exports were £27.9bn lower than imports on this measure of the underlying strength, a gap representing 4.5 per cent of national income, the highest since comparable records began in 1997.

Bar chart of Quarterly change in output (%) showing Ending Covid testing reduced health service output, but travel boomed

Much of this deficit reflects imports of expensive oil and gas, but there have also been notable increases in imports of vehicles and machinery from the EU without corresponding rises in exports.

On a sectoral basis, the main decline in output in the second quarter came in services, particularly in the health sector and in retailing, offset by improvements in services related to the booming travel sector. Manufacturing contracted slightly, as did the North Sea oil and gas sector despite record prices.

The figures show that the UK economy was 0.6 per cent larger than it was in the quarter immediately before the pandemic, but significantly smaller than expected at the time, suggesting lasting damage to economic performance.