UK economy stagnates as high interest rates take their toll

After demonstrating unexpected resilience this year despite the rising cost of living, the British economy has weakened noticeably. The services sector contracted last quarter as the highest interest rates since 2008 have weighed on the real estate industry.

The manufacturing industry also slumped, while repairs helped offset the decline in new jobs in the construction sector.

According to the statistics agency’s monthly GDP breakdown, the economy grew 0.2 percent in September, slightly more than in August, after a 0.6 percent drop in July.

Britain’s weak economy reflects stagnation in Europe, where eurozone economies contracted 0.1 percent in the third quarter. Germany, the bloc’s largest economy, has barely avoided a recession as businesses have been hit by high energy prices and weak demand for industrial goods. Across the region, high interest rates aimed at reducing inflation are weakening economic activity, with demand for loans falling and consumer spending slowing.

This contrasts with the United States, where the economy is growing strongly and defying expectations of a slowdown caused by high interest rates. Instead, slowing inflation and a resilient labor market have bolstered consumer confidence to spend.

According to the Bank of England, the British economy is not expected to fall into recession, but it will only avoid this distinction by a hair’s breadth. The central bank forecasts GDP will rise just 0.1 percent in the final three months of the year and then stagnate throughout 2024 and early 2025.

This weak outlook is due to high interest rates, which are expected to come at an increasingly higher cost to the economy. Less than half of the full effect of higher rates has been felt so far, the central bank estimates, and policymakers expect the restrictive effects to shift from the housing market to business investment and consumer spending.

Economists at the National Institute for Economic and Social Research, an independent research institute, said this week they expected “slow” economic growth this year and next, but slightly stronger activity than the Bank of England forecasts.

“The bottom line here is that the UK is almost at a standstill, moving very slowly,” said Stephen Millard, deputy director of the institute, “and precise figures are almost beside the point.” Around five million people in the lowest income groups will not see their standard of living return to pre-pandemic levels until 2026, the institute predicts.

Chancellor of the Exchequer Jeremy Hunt will announce updates to the country’s budget later this month, which he said would focus on “how to get the economy back to healthy growth” through private investment and encouraging more people to go back to work.

But Hunt is not expected to make substantial changes to taxes or spending due to constraints imposed by another of his priorities: reducing the national debt as a percentage of GDP.

Even if the country’s public finances appear to be in better shape than expected, most analysts expect Hunt to wait until the next election, due in January 2025, to offer fiscal sweeteners. But economists at the National Institute of Economic and Social Research have urged the government to significantly and urgently increase public investment, particularly in infrastructure and housing.