How to spot a recession

The good news is that we seem to have seen the last of rate hikes. The bad news is that half the impact of higher interest rates is yet to feed through to the economy. Given that growth is already stagnant (GDP rose by just 0.3 per cent between June and August this year), is a recession on the horizon?

The past: historical patterns point to trouble ahead

Although it might sound counterintuitive, looking backwards tells us a good deal about the conditions typically in place before a recession sets in.

Analysis from Deutsche Bank identified the conditions historically most likely to precede a recession: a yield curve inversion, a 2.5 percentage point increase in interest rates, and inflation rising by three percentage points. Discouragingly, the UK economy currently satisfies all three. 

But it goes without saying that the future will never be a perfect reflection of the past. None of these measures has a fantastic hit rate for the UK economy (see chart), and Deutsche Bank strategist Jim Reid points out that “the fact that nothing here is above 80 per cent shows that it's impossible to accurately predict every recession using macro triggers”. 

The present: PMIs and confidence data imply a gloomy outlook

It takes six weeks to publish monthly gross domestic product (GDP) data, and even longer to collate quarterly figures. As a result, more immediate survey measures can give us a valuable sense of how the economy is faring. 

Unfortunately, the latest figures were not encouraging. The composite purchasing managers index (PMI) inched up from 48.5 in September to 48.6 in October, but remains at a level historically consistent with a contraction in GDP. Business optimism weakened for the first time since July, and sharp falls in growth expectations were seen in both the manufacturing and services sectors. 

Consumers are feeling similarly pessimistic. GfK’s consumer confidence index fell by nine points to minus 30 in October, with consumers reporting concerns about the cost of living and surging mortgage and rental rates. GfK’s major purchase measure dropped by 14 points, marking an inauspicious start to the pre-Christmas retail season.

GfK’s Joe Stanton expects little improvement over the months ahead. Following the release, he said that “the volatility we are seeing in consumer confidence is a sure sign of a depressed economic mood and there’s no immediate prospect of any improvement”.

The future: forecasts suggest stagnation, not recession

According to an average of forecasters polled by the Treasury last month, economists expect the UK economy to stagnate in the third quarter of the year, before expanding by 0.1 per cent in Q4. This will be followed by paltry (though positive) growth of 0.5 per cent in 2024.

But the average figures belie some significant differences in opinion. Analysts at Capital Economics think that the economy will contract in both Q3 and Q4 as higher interest rates drag on growth, leading us into a mild recession by the ‘technical’ definition. Economists at EY ITEM club are more optimistic, and expect us to avoid a contraction this year and next. They add that the fact we have avoided a long-awaited recession so far “suggests a welcome degree of resilience” in the UK economy.

Forecasts are, after all, only as good as the assumptions that underpin them – and these can rapidly go out of date. Around a year ago, the Bank of England forecast one of the longest UK recessions on record. We are still waiting for it to hit today. Last month’s International Monetary Fund (IMF) forecasts faced criticism when they released gloomy projections based on the assumption that UK interest rates would rise to 6 per cent, something that now looks vanishingly unlikely. 

Overall, the UK economy looks destined for a period of very low growth over the coming quarters – but should avoid an outright contraction. Yet economists at EY ITEM club point out that “the very subdued growth we expect over the rest of this year and into 2024 won’t feel much different from a recession”. Dodging recession on a technicality might feel like cold comfort this winter.