What is a recession and how will it affect you?
The UK economy is heading towards a recession, according to economists. But what is a recession, and what does it mean for your money?
What is a recession? That’s going to be a question a lot of people might be asking right now considering recent headlines.
While the term might sound scary, a recession is more of a technical term than anything else.
What is a recession?
In its simplest form, the UK is in a recession if its economy contracts for two successive quarters.
That is enough to qualify as a significant, widespread, and prolonged downturn in economic activity.
The size of the economy is measured in terms of gross domestic product (GDP), which aims to take into account all the economic activity that goes on in the country.
According to the Office for National Statistics (ONS), GDP is made of three main components:
- The value of all goods and services produced by the economy
- The country’s overall spending, including business, personal and government spending
- Income across the country, including wages, business profits and international trading income
As you might guess the ONS does not have all of these figures to hand all of the time. So, it uses estimates based on surveys and government spending data to come up with its GDP figures.
Still, GDP is seen as a reliable indicator of the size of a country’s economy. The ONS publishes its estimates on the size of the economy once a quarter and these are used by economists to determine the health of the economy.
If GDP declines it means the economy is contracting and economic activity is slowing. If it grows, it means the economy is expanding, more money is changing hands and the country is generally getting richer.
But if GDP shrinks for two quarters in a row, economists define this as a recession, a sign that the economy is in trouble.
Is the UK heading for a recession?
According to the latest data from the ONS, GDP fell by 0.2% between the second and third quarter. Preliminary figures also suggest the economy contracted by 0.6% between August and September.
The Bank of England, which has a network of economists and data researchers plugged into the plumbing of the UK economy, believes the country is going to slump into a recession over the next few months and will be “in a recession for a prolonged period.”
The latest figures from the ONS seem to support this view.
According to the BoE’s projections, the economy is expected to remain in a recession for 2023 and the first half of 2024.
Policymakers are blaming inflation, the war in Ukraine and political uncertainty for the slump.
However, as is the case with all economic projections, these are just forecasts. There’s a lot that can change over the next two years which could have an impact on the UK’s economic position.
For example, Jeremey Hunt’s budget on 17 November could have a significant effect on future economic growth if the chancellor decides to slash government spending.
Equally well, if the war in Ukraine reaches an uneasy stalemate, commodity prices could fall and take the edge off inflation, giving consumers more spending power and driving economic growth.
It’s also worth noting that economic activity in September was hit by the Queen’s funeral. As Nicholas Hyett, an equity analyst at Wealth Club, says, “Were it not for the disruption caused by the Queen’s funeral – during which many businesses shut – it’s just possible the UK economy could have scraped a positive performance in Q3.”
Why is a recession bad news?
Recessions are bad news because they mean people and businesses are spending less. If people are spending less, companies might decide to stop hiring new staff or even let existing staff go to offset declining sales.
This can have a knock-on effect on the rest of the economy. Companies lay staff off because sales are falling, which means these consumers will have less money to spend, which means companies will see sales decline, which means they’ll have to cut costs, and so on.
Just the talk of a recession can send a chill through the business community. No one wants to commit to a large investment project if they think demand is about to drop due to a recession.
It’s also common for banks to reduce their lending during an economic downturn, making it harder to borrow money for growth projects and meet working capital requirements.
As a result companies tend to hold on to what cash they have and delay spending projects.
Once again, these delays can only accelerate the downturn.
What does a recession mean for you?
Recessions can affect different people in different ways. Just because the economy is technically shrinking it does not mean you’re going to lose your job or house.
Indeed, the term recession itself is pretty hit and miss as it only measures the state of the economy as a whole, and does not take into account specific regions and markets.
For example, in the fourth quarter of 2021, the UK economy as a whole grew 1.3% year-on-year. However, London’s economy expanded 3.1% while economic activity in Yorkshire and the Humber shrank -0.8%.
There are also sector differences. The latest figures from the ONS show that despite the overall decline in GDP between the second and third quarter, the construction sector continues to and the services sector is treading water.
Recessions can also have different effects on people in different income brackets. Those on benefits or fixed incomes such as retirees are more likely to struggle especially in the current cost of living crisis.
Graduates and school leavers may find it harder to get their first job, and companies might be more reluctant to give promotions or pay rises.
It’s always sensible to keep at least three months spending in a cash savings account if you can to act as a cushion against disaster.
And it could be worth taking a look at your current spending. Inflation is driving the price of everything higher, and it might make sense to cut back spending in some areas to make sure your outgoings do not exceed your income.
Searching out other ways to earn an income, or getting a better deal on your mobile bills, savings accounts and other expenses such as car or home insurance could also help you improve your financial position ahead of a downturn.