UK GDP: Economy falls unexpectedly

The UK economy shrank by 0.3% in October, according to the Office for National Statistics (ONS), as high interest rates hit household spending.

The fall was bigger than expected: most economists had forecast a reduction in GDP of just 0.1%.

The news follows growth of 0.2% in September.

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Consumers have been squeezed by high interest rates, which has put a lid on their spending. Meanwhile, the retail and tourism sectors were affected by Storm Babet hitting the country in October.

The Bank of England will make its next interest rate decision tomorrow (Thursday) and is widely expected to keep rates at 5.25%. 

Chancellor Jeremy Hunt said: “It is inevitable GDP will be subdued whilst interest rates are doing their job to bring down inflation. But the big reductions in business taxation announced in the Autumn Statement mean the economy is now well placed to start growing again"

We look in more detail about why GDP fell in October, and what it means for interest rates.

Why is the economy shrinking? 

In terms of the October figures, the economic contraction reflects a 0.2% fall in the services sector, particularly in information and communication activity driven by weaker computer programming activity and a slowdown in film activity.

Consumer services fell 0.1% month-on-month, while construction output fell 0.5%.

Nicholas Hyett, investment analyst at Wealth Club, said: “While the crucial services sector has been negatively affected by US actor strikes, which is a bit of a one-off, the rest of the GDP report paints a gloomy picture. Manufacturing is down nearly 1% and house building activity has fallen nearly 5%.”

The consultancy Capital Economics said some of the fall in economic growth was due to the “unusually wet weather”. Paul Dales, chief UK economist, added: “That said, the weakness was broad-based, which indicates the ongoing drag from higher interest rates is more than offsetting any boost from the rise in real wages.”

Although GDP shrank by 0.3% in October, looking across a three-month period can give a better indication of the health of the economy.

According to the ONS, the UK economy flatlined in the three months to October, compared with the previous quarter.

Hyett commented: “GDP has gone nowhere over a three-month period, as a bleak October offset some more positive numbers from the end of the summer.

Dales added: “Whether or not the economy contracts, the big picture is that it remains very subdued and that’s probably going to be the story for 2024. Our 2024 GDP growth forecast of +0.1% is weaker than the consensus of +0.5%.” 

What does it mean for interest rates? 

Interest rates are at a 15-year high of 5.25%, and are likely to remain high for some time.

Analysts believe the Bank of England will leave interest rates at 5.25% when it meets tomorrow, its final meeting of 2023.

The fall in GDP in October could nudge the Bank slightly closer to cutting interest rates.

Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales, said: “With inflation trending downwards and the economy at risk of recession, the case for cutting interest rates is likely to grow.”

However, the markets are generally expecting that a rate cut won’t happen until mid-2024. Capital Economics predicts that the first rate cut won’t happen until late next year.