UK faces ‘heightened recession risks’ as interest rates bite

The UK economy is on course to shrink in the three months to the end of September and could tip into recession, a closely-watched survey suggests.

The S&P Global/CIPS UK purchasing managers' index found rising interest rates and weaker household spending contributed to a sharp drop in demand for goods and services in August.

The index fell to 47.9 in August - its lowest level in two and half years - down from 50.8 in July.

Anything below 50 marks a contraction.

Economists suggested that PMI figures, which are a measure of the health of the economy, showed that the Bank of England's efforts to tame inflation - the rate at which prices rise - were beginning to work.

After the report, the pound fell and City analysts lowered their expectations of where the Bank's interest levels would peak to 5.5% from 6%. Rates currently stand at 5.25%, up from close to zero in late 2021.

However, Chris Williamson, chief business economist at S&P Global Market Intelligence, said the figures also suggested "the fight against inflation is carrying a heavy cost in terms of heightened recession risks".

"A renewed contraction of the economy already looks inevitable, as an increasingly severe manufacturing downturn is accompanied by a further faltering of the service sector's spring revival," he said.

According to official figures, UK inflation was 6.4% in July which, although slower than the previous month, is still near record levels and much higher than the government's aim of 2%.

In response the Bank has put up interest rates 14 times since 2021, hoping that by making it more expensive to borrow money, consumer demand will cool and price rises will slow.

However, repeated interest rate rises tend to drag on economic growth as it becomes more expensive for consumers and businesses to borrow and spend.

Paul Dales, economist at Capital Economics, said the survey would encourage the Bank "that higher rates are working" but added that economic would soon contract and a "mild recession is on the way".

According to the PMIs, both the UK activity fell in both the manufacturing and services sectors in August.

Rhys Herbert, a senior economist at Lloyds Bank, added that "the sharper-than-expected drop in retail sales in July" was also a warning of "further possible weakness as we enter autumn".

"Some businesses continue to also experience challenges with recruitment, resulting in upward pressure on wages," Mr Herbert added.

Pay has been rising at a record rate but the Bank of England has warned that wage increases will make it harder to get inflation down.