Monday, June 27, 2022

Pound tumbles as recession fears mount after UK economy shrank

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The pound fell against the dollar and UK stock markets plummeted on Monday after bleak figures showed the country was headed for recession.

The economy contracted unexpectedly in April amid skyrocketing prices for essential goods, rising interest rates and record high fuel costs.

Experts said the data is now catching up with the “cocktail of challenges” the UK is facing, with the potential for more problems as trade relations with the EU deteriorate.

Official figures showed that Britain’s gross domestic product (GDP) – a measure of all goods and services produced – fell 0.3 percent in April after contracting 0.1 percent in March and showing no growth in February.

Markets reacted strongly to the news, with London’s FTSE 100 index of leading stocks falling 1.5 percent and the pound 1.5 cents against the dollar. Sterling was trading at $1.216 as the London Stock Exchange closed on the day.

Across the Atlantic, Wall Street screens flashed red as the S&P 500 opened back down, shedding 2.4 percent of its value in morning trading.

The index is now in a bear market, having lost a fifth of its value since the recent peak in January. The tech-focused Nasdaq has now lost more than 30 percent of its value since its recent peak.

High-growth tech stocks like Peloton and Zoom have faltered in recent weeks, erasing huge gains made early in the pandemic.

The sell-off came as central banks hiked interest rates in a bid to cool the economy and slow the rate of inflation.

Fears are growing that central banks will have to act more restrictively or that inflation will soon become difficult to control.

In April, electricity bills in the UK rose 54 per cent, while workers were hit by an increase in social security. Meanwhile, food and fuel prices have skyrocketed after supplies were severely disrupted as a result of the Russian invasion of Ukraine.

The Office for National Statistics (ONS) said on Monday that UK GDP is now 0.9 percent above pre-pandemic levels but 0.4 percent below the peak reached in January. Experts had expected GDP to increase by 0.1 percent in April.

The ONS said it was the first time since March and April 2020, when the pandemic first struck and the economy collapsed, that GDP had fallen for two straight months.

In the service sector, which accounts for more than three-quarters of the UK economy, production shrank by 0.3 percent. This was mainly due to the end of the government’s Covid-19 Test and Trace program and reduced vaccination activity.

The end of free testing reduced GDP by 0.5 percentage points. Excluding the impact of testing and trace and vaccines, production would have risen 0.1 percent in April, the ONS said.

Activity also declined in the other two major sectors of the economy. Manufacturing shrank 1 percent as companies reported being hit hard by sharp price hikes and delays in deliveries. Construction output fell by 0.4 percent.

Last week, the OECD Group of Wealthy Nations released forecasts predicting that the UK would fall behind all other advanced economies except Russia over the next year as growth plummets to zero.

Analysts were divided on whether the UK would avoid a recession, defined as two consecutive quarters of negative economic growth.

Martin Beck, chief economic adviser to the EY Item Club, said the outlook was bleak.

“An already serious squeeze on household purchasing power is being negatively impacted by the inflationary impact of global supply chain frictions and recent sterling weakness,” he said, adding that UK interest rates are likely to rise again later this week.

The Bank of England is expected to announce its latest interest rate decision on Thursday, with markets anticipating further increases.

The bank’s monetary policy committee is trying to tame inflation, which is expected to hit 10 percent later this year, well above the 2 percent target rate.

Further increases will continue to weigh on household budgets and are expected to slow consumer spending, which will weigh on the broader economy.

Samuel Tombs, UK chief economist at Pantheon Macroeconomics, said private sector activity had helped offset a sharp fall in Covid-related government spending and “renewed weakness” in manufacturing. However, a recession remains unlikely, he said.

“Households’ real disposable income should rise in both the third and fourth quarters after the Chancellor announced an additional £5bn in grants for those quarters, almost 2 per cent of her expected income in those quarters.

“Assuming energy prices stall and households are cautious about drawing on their savings, we expect quarterly GDP growth to be around 0.6 percent in the third quarter and 0.5 percent in the fourth quarter,” he added.

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