UK economy shrinks by 0.3% on back of manufacturing slump

Britain’s economy shrank by 0.3% in August from July, hit by a slump in manufacturing and by maintenance work that slowed the oil and gas sector, official data showed.

Giving a strong signal that the UK is entering a recession, the Office for National Statistics said manufacturing declined by 1.6% while the cost of living crisis appeared to hit hotels, restaurants and the leisure industry.

A Reuters poll of economists had pointed to zero growth in August rather than a 0.3% decline.

The decline in gross domestic product (GDP) was also 0.3% over the three months to August, indicating that an increase of 0.1% in July was a blip and mostly caused by a modest rebound from the Queen’s platinum jubilee celebrations.

A rise in housebuilding activity offset a decline in maintenance to leave the construction sector 0.4% larger.

However, the much larger services sector shrank by 0.1% as a result of cuts to health service spending. Output fell by 5% in the arts, entertainment and recreation sector and by 1.8% in the food and accommodation services sector.

A reduction in state spending related to the coronavirus pandemic was also one of the big causes of the slump in manufacturing, which was hit by pharmaceutical companies cutting back production.

Kwasi Kwarteng, the chancellor, blamed the global situation for the decline and especially the war in Ukraine, which has sharply increased energy costs.

“Countries around the world are facing challenges right now, particularly as a result of high energy prices driven by Putin’s barbaric action in Ukraine,” he said.

“Our growth plan will address the challenges that we face with ambitious supply-side reforms and tax cuts, which will grow our economy, create more well-paid skilled jobs and in turn raise living standards for everyone.”

However, Rachel Reeves, the shadow chancellor, said the GDP figures showed the economy was “in a dire state” for which the government should take the blame.

“Mortgage costs are soaring, leaving families worrying about making ends meet. Borrowing costs are up. Living standards down. And we are forecast to have the lowest growth in the G7 over the next two years,” she said.

Charlie Bean, a former Bank of England deputy governor, said the economy was sliding towards stagnation. Speaking on BBC radio, he added that the contraction was likely to be short-lived if the government pressed ahead with a large injection of extra money into the economy in the form of tax cuts and financial assistance with energy bills as outlined in the mini-budget.

He cautioned that the budget measures needed to be credible, and urged the chancellor to bring forward more details about how the tax-cutting plans will be funded to reassure financial markets.

The cost of government borrowing leapt after Kwarteng said he planned to spend £45bn over the next four years mainly on tax cuts, as well as the £150bn energy price cap during his mini-budget, spooking financial markets.

The pound dropped in value and pushed up the cost of borrowing. In only three weeks the cost of a two-year fixed-rate mortgage has increased sharply to more than 6%.

The TUC general secretary, Frances O’Grady, said, with inflation running at 10%, “the government must come forward with a plan to get wages rising faster”.

She backed calls for an increase in universal credit to keep pace with rising prices, “otherwise a deeper spending slump will push the UK further towards recession”.

Martin Beck, the chief economic adviser to the EY Item Club, said the fall in manufacturing output was “particularly significant”, and recent business surveys showed it was likely to continue through the autumn.

He said the extra bank holidays in the summer for the platinum jubilee had pushed some activity from the middle of the year into the winter months, leading to a rebound in the fourth quarter that would “likely mask underlying weakness”.

An inflation rate of 9.9% would continue to eat into household spending power, he added, while the recent rises in mortgage and business loan costs “could well add to the real income squeeze and potentially cause a house price correction”.

Samuel Tombs, the chief UK economist at Pantheon Macroeconomics, said August’s drop in GDP likely marked the start of a downward trend that will continue deep into next year.

Kitty Ussher, the chief economist at the Institute of Directors, said it was possible the economic slowdown would bring down prices “making it unnecessary to raise interest rates further”.

The Bank of England was unlikely to subscribe to this view with unemployment at record lows, she added, and so “the Bank of England is likely to judge that further interest rate rises are needed”.

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