UK economy plunges into a recession

LONDON – Sterling plunged seven cents against the dollar and the FTSE tumbled 5pc after official figures confirmed that Britain is on its way to its first recession since the early 1990s. UK gross domestic product fell by 0.5 per cent, the first contraction since the second quarter of 1992, and the biggest drop since the fourth quarter of 1990. Economists had expected a drop of 0.2 per cent.

Sterling plunged seven cents against the dollar and the FTSE tumbled more than 7pc after official figures confirmed that Britain is on its way to its first recession since the early 1990s.

"This is once-in-a-lifetime stuff, we’re all sat under our desks with tin hats on,” said Neil Mellor, a currency strategist at Bank of New York told Bloomberg.

Vicky Redwood, UK economist at Capital Economics, said: "Not only do Q3’s GDP figures confirm that the UK has entered a recession, but the 0.5pc drop is truly shocking."

The cocktail of bad news coming from the economy has hammered sterling and the FTSE 100 this week. The pound was down seven cents at $1.55 in mid-morning trading and the FTSE tumbled more than 6pc. London Stock Exchange, HBOS and Barclays lead the fallers after dramatic declines in Asia.

The grim data suggest that the UK will be in technical recession – two consecutive quarters of negative growth – by the end of the year and follows declarations this week from the Prime Minister and the Bank of England’s Governor Mervyn King that the country is in recession.

Many of the symptoms of a deep slowdown are already present, including a sharp rise in unemployment, falling house prices, low wage growth and faltering business confidence.

The decline of the economy in the third quarter was predominantly caused by an unexpected 0.4pc contraction of the services sector, which, accounting for three quarters of GDP, makes up the lion’s share of the economy.

Hotels and restaurants were particularly badly hit as consumers chose to cut back on unnecessary spending. Combined with distribution, hotels and restaurants output fell by 1.7pc in the third quarter.

Manufacturing and industrial production output both fell by 1pc, signalling that the latter is already in recession as output contracted by 0.7pc in the second quarter.

"For the services sector to shrink for the first time since 1992 marks a turning point in the economic fortunes of the UK," said Hetal Mehta, senior economic advisor to the Ernst & Young ITEM Club.

"We’ll get confirmation [of recession] in January when the quarter four numbers are out, but today’s figures highlight how serious the situation is."

The debate among economists has now turned to how severe a recession in the UK may be. Earlier this week, the National Institute of Economic and Social Research revised down its forecasts for the UK and now predicts that the economy will contract by 0.9pc in 2009 – the first full year recession since 1991.

The Bank of England is expected to try and lower the chances of a severe recession with a series of aggressive rate cuts. It already made the unprecedented move of slashing rates by 50 basis points at an emergency meeting of the Monetary Policy Committee two weeks ago.

The pound has been hammered in recent days over fears that the UK will suffer a longer and deeper recession than other countries, and over the expectation that the MPC will more aggressively cut rates than other countries. That is largely because at 4.5pc, interest rates in this country are high compared with other countries, so the MPC should have room to cut than other central banks.

How the last recession unfolded

1990

Q3 – Economy shrank by 1.2pc

Q4 – Economy shrank by 0.6pc

1991

Q1 – Economy shrank by 0.1pc

Q2 – Economy shrank by 0.3pc

Q3 – Economy shrank by 0.4pc

Q4 – Economy grew by 0.1pc

1992

Q1 – Economy grew by 0.1pc

Q2 – Economy shrank by 0.2pc