What is a recession and how will it affect you?

In his Spring Budget the chancellor revealed the UK would avoid a technical recession in 2023, despite previous forecasts, as the economy was “proving the doubters wrong”.

But despite avoiding the two consecutive quarters of decline that constitute a recession, the Office for Budget Responsibility still expects the economy to shrink by 0.2% in 2023.

Additionally, savings rates on 12 month savings accounts are now higher than those of five-year fixed savings accounts, which could also indicate a recession is coming.

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So, what is a recession and how will it affect you?

What is a recession?

A recession is a period of economic decline, typically defined as a decline in a country's gross domestic product (GDP) for two consecutive quarters or six months.

This is typically accompanied by high unemployment and a decrease in business activity and consumer spending. Recessions are a normal part of the economic cycle, but they can have severe consequences for individuals and businesses.

The size of the economy is measured in terms of 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:

1. The value of all goods and services produced by the economy
2. The country’s overall spending, including business, personal and government spending
3. 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.

The health of an economy can be measured by a variety of indicators, including GDP, unemployment, and inflation. A healthy economy is typically characterised by strong economic growth, low unemployment, and low inflation.

Overall, the health of an economy is determined by a combination of these and other factors. A healthy economy is one that is growing, with low unemployment and stable prices, and that is able to provide opportunities for individuals and businesses to thrive.

Is the UK heading for a recession?

The Office for Budget Responsibility (OBR) said in March it expects the UK economy will shrink by 0.1% in 2023, but that the country will avoid slipping into a technical recession.

This forecast was also more upbeat than the OBR’s previous one, made in the Autumn Statement, where it said it expected the economy would shrink by 1.4% in 2023.

The Bank of England also said it no longer expects the UK to enter a recession. But the International Monetary Fund has said it expects the UK economy to shrink this year, revising its forecast to -0.3% from -0.6% previously.

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 affect the UK’s economic position.

For example, 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.

Can savings rates predict a recession?

Rising savings rates could also be a sign a recession is coming.

“The best rate for a 12 month savings account is higher now than that of a 5-year fixed rate savings account according to Moneyfacts data,” says Emma Wall, head of savings at Hargreaves Lansdown.

“This is great news for savers only wanting to lock their money away for a short period – but if flips interest rate logic on its head. Normally, the longer the term the better the rate, you’re compensated for your loyalty.”

This is an indication that the yield curve is inverted.

A yield curve maps the relationship between the yield on bonds and their maturities.

Typically a yield curve will go upwards because investors expect they will be paid more interest the longer they lock their investments in for.

But once the curve starts tilting downwards, it suggests the market expects long-term interest rates to fall.

“The yield curve normally plots low for one-year fixed rate, ticking upwards from bottom left to top right,” says Wall. “This shape usually indicates that we are in a period of economic expansion, optimism abounds.

“An inverted yield curve is a line that sweeps downwards – top left to bottom right, and indicates the opposite, a period of economic contraction – a recession. A flat line usually means change is afoot!”

“Currently plotting the best savings rate for one, two, three and five year accounts the line sits somewhere between all three, trending slightly down towards the five year,” continues Wall. “This indicates economic uncertainty – the outlook for how the Bank of England will next act on rates is mixed.”

Indeed, the latest inflation figures have prompted many analysts to predict the BoE’s base rate will climb to 4.50% or even 5.% by the end of the year. But members of the Monetary Policy Committee have indicated they’re split on whether or not to hike the base rate further, as doing so would continue to slow down the economy.

Of course, an inverted yield curve is not necessarily an indicator of a recession. But it does mean that for investors, now is the time to snap up attractive short-term rates on one-year fixed savings accounts.

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.

And when combined with the threat of higher interest rates, this combination of factors could lead to tight financial conditions - a situation in which it is difficult for individuals and businesses to access credit or to obtain financing for their activities.

Tight financial conditions can have negative effects on the economy, as they can make it difficult for businesses to invest and expand, and they can reduce consumer spending. This can lead to a decrease in economic growth and potentially higher unemployment.

What does a recession mean for you?

A recession can have a number of impacts on individuals, depending on their circumstances.

For some, a recession may mean losing their job or seeing their hours reduced, leading to a decrease in income and difficulty paying bills. It can also mean that businesses may be less likely to hire new employees or invest in new projects, which can make it harder for individuals to find new job opportunities.

On the other hand, a recession may also mean that interest rates are lowered, making it cheaper to borrow money and potentially benefiting those with outstanding loans.

Overall, a recession can be a difficult time for many people, but the specific impacts will vary depending on a person's individual situation.

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.