- The UK economy has technically entered recession
- But markets are looking ahead to rate cuts
The UK economy is officially in recession. Gross domestic product (GDP) contracted by 0.1 per cent in the third quarter of 2023, followed by a 0.3 per cent contraction in Q4. We have seen the two consecutive quarters of negative growth that technically constitutes a recession.
Why not to worry
Yet as recessions go, this looks set to be a very mild one. So far, the UK economy has seen a 0.5 per cent peak-to-trough decline, one of the smallest in the post-war period. As the chart below shows, the economy contracted by a huge 6.4 per cent after the financial crisis, and by 2.4 per cent in the early 1990s downturn.
In the US, they might not even class this contraction as a ‘recession’ at all. Instead of relying on the ‘two consecutive quarters rule’, designating a US downturn is left up to the NBER’s Business Cycle Dating Committee. Here, economists look for a significant decline in economic activity, and wider signs of recession visible in production, employment and real income figures.
In the UK today, the unemployment rate is 3.8 per cent. This is low by historical standards and far lower than the 8.4 per cent it reached in the aftermath of the financial crisis. Retail sales are also holding up relatively well, shooting up by 3.2 per cent month on month in January. Economists at Deutsche Bank now expect this domestic spending to add about 0.15 percentage points to January’s GDP growth. According to these wider measures, the UK economy is looking far more resilient.
There is even a chance that such a mild contraction could disappear as the Office for National Statistics (ONS) refines its estimates of last year’s GDP growth. Deutsche Bank economist Sanjay Raja thinks that the likelihood of this technical downturn being ‘revised away’ by new data is high, especially given it is so mild. Nicholas Hyett, investment analyst at Wealth Club, says that “whether today's recession transforms into something that's remembered outside the pages of an economic history textbook remains to be seen”.
Markets move faster than economic statistics do
But this recession is not only mild – it is also old news. Ed Monk, associate director at Fidelity International, points out that markets tend to be forward looking, meaning that “investors will already be looking past data on recent economic performance”.
AJ Bell's head of investment analysis, Laith Khalaf, noted that the stock market as “a forward-looking weighing machine” has largely shrugged off the news. After all, a 2023 downturn doesn’t change prospects for companies in the future. Economists at the NIESR think tank expect GDP to grow by 0.2 per cent in the first quarter of 2024, meaning that recession could already be firmly in the rearview mirror. Stagnation, rather than a deep contraction, is the reality facing firms today.
It is also worth stressing that around 75 per cent of FTSE 100 revenues come from overseas, and around 60 per cent for the FTSE 250. The UK economy is not the UK stock market.
The big question is still when rates will be cut
For UK investors, the biggest question is still when the Bank of England (BoE) will cut rates. Tellingly, market expectations for rate cuts moved relatively little in the aftermath of the latest GDP data, and traders are still pricing in around 0.75 percentage points of cuts this year.
Economists don’t expect the recent GDP data to move the dial for the BoE, either. Imogen Bachra, head of non-dollar rates strategy at NatWest, thinks that rate-setters are more worried about signs of inflation persistence than activity. This means that recession is “arguably less important” for both the BoE and markets than labour market and inflation figures.
Tomasz Wieladek, chief European economist at T. Rowe Price, thinks that mixed economic data could see markets “pulled in two different directions” over the next few months. Resilient labour market figures could dash hopes of rate cuts, meaning gilts sell off, while positive inflation data could see markets price in more rate cuts, meaning that gilts rally. “The debate about whether and when to cut will continue and the timing of the first rate cut will remain highly uncertain”, he added.
