Welcome to 2022. Inflation is high, interest rates are rising and the stock market is falling. With all this going on, the question undoubtedly gnawing at the back of many people’s mind is “will there be a recession in 2022?”
Table of Contents
What Is a Recession?
First and foremost, what is a recession? Many people use the term without realising that, in the UK at least, it has quite a specific definition.
Whilst this is the traditional definition of the term, in the US, the National Bureau of Economic Research (NBER) – which is responsible for officially declaring recessions – did away with the two consecutive quarter requirement, and now defines it as such:
“A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” 1
What Is Economic Growth?
For the purpose of this article, we will stick to the generally accepted definition of recession, which is defined by two consecutive quarters (i.e. six months) of negative economic growth. So, to really understand what a recession is, we need to also define economic growth.
Economic growth is the increase in the production of goods and services within an economy from one period of time to another. It is usually measured by Gross Domestic Product (GDP), which is the value of all finished goods and services produced in an economy during a certain time period.
There are three different ways to calculate GDP, all of which should equate to the same value:
- The total value of goods and services produced;
- Total income of everybody in the country; or
- Total spending within the economy
The most familiar of these three methods is the third, which is calculated by finding the sum of the following:
- Consumer spending
- Investment
- Government spending
- Net exports (total exports – total imports)
When the sum of these components rises, GDP increases and vice versa. When GDP increases, people are spending more and businesses are producing more. When GDP falls, people are spending less and businesses are producing less.
When GDP falls for two consecutive quarters, the economy has entered a recession.
Will There Be a Recession in 2022?
In the UK, GDP increased by a modest 0.8% in the first quarter of 20222. This means that, technically, the earliest that the UK could officially enter a recession would be after the third quarter (i.e. October). But will it happen?
The short answer is, yes, there is likely to be a recession in 2022. But why? And what does that mean for us?
High Inflation
Thanks to rising oil prices, continued supply disruptions caused by the pandemic, the situation in Ukraine and more than a decade of loose monetary policy, global inflation is high.
In the UK, inflation hit 9% in the 12 months leading up to April 20223 – its highest level since 1982 – and whilst steps are being taken to bring this under control, it won’t happen overnight.
The likelihood is that inflation will get worse before it starts to get better, with the Bank of England (BoE) forecasting that inflation will peak at 11% later this year4.
Why does high inflation impact economic growth?
Inflation measures the rate at which the cost of goods and services are rising over time, or the rate at which money is losing its purchasing power. When inflation is rising, but incomes remain the same, peoples’ real income is falling, meaning that, over time, their income cannot buy as much as it could before.
This has the end result of consumer spending falling, as well as negatively impacting consumer confidence, which reinforces the downwards effect on consumer spending.
Above, we looked at the four components used to measure total spending within an economy. Of these components, consumer spending is by far the highest, accounting for 59% of GDP in the UK in 20215. Therefore, if consumer spending falls, GDP is likely to follow suit.
Interest Rates Rising
High inflation is an undesirable feature in an economy and, in most developed economies, central banks are tasked with making sure it stays low. The most common way for them to do this is to raise interest rates.
On 15 June, the US Federal Reserve raised their base lending rate by 75 basis points (bps)6 and the BoE raised their base rate by 25 bps on 16 June7, their fifth increase since December 2021.
Interest rate rises result in people spending and investing less, which helps cool down inflation, but also has also have the undesired effect of potentially reducing GDP. Interest rate rises result in a fall in consumption and investment for three main reasons:
- Mortgage and other loan repayments, which are usually tied to the base lending rate, increase, which reduces disposable incomes, meaning people have less money to spend.
- Higher interest rates incentivise people to save money and collect interest rather than spend or invest it.
- Consumers are less inclined to borrow money to fund purchases as the cost of borrowing has increased.
Higher interest rates don’t just impact consumers, but also businesses, whose profits are negatively affected by the increased cost of servicing debt and, therefore, they invest less in their future growth.
Interest rate rises, therefore, cause consumer spending and investing to fall, which in turn is likely to cause total GDP to fall.
What Happens if There Is a Recession?
If the economy enters a recession, we can expect the stock market to suffer as businesses feel the weight of reduced consumer spending and investors shun stocks in favour of less risky destinations for their money.
Whilst this may be scary for those new to the stock market or those who trade over a shorter time frame, for more experienced and longer-term investors, a stock market crash – although, naturally, concerning – should not cause too much panic and may even provide an opportunity to pick up cheap, quality stocks.
Although undoubtedly unpleasant, recessions are a normal and unavoidable part of the economic cycle and, whilst some have lasted longer than others, the economy has always recovered over the longer-term. In the UK alone, there have been eight recessions since 19568.
Another possible consequence of recession is an increase in unemployment, as businesses attempt to cut costs where possible. However, in the UK at least, there is certainly no sign of this happening at the moment, with unemployment reported in the first quarter of 2022 at its lowest level in 50 years9.
How to React to a Recession
First and foremost, it is important to ensure that you have sufficient savings set aside to allow you to deal with any unforeseen circumstances and, if necessary and possible, reduce consumption to help achieve this.
The negative consequences of recessions will naturally make everyone a little bit more risk averse. However, as noted already, recessions also create investment opportunities for those with income to spare. As many people cash in on their investments, whether it be through fear or necessity, sell-offs will ensue and asset prices will fall. This means that some investors may be able to pick up quality stocks for cheaper prices.
If we enter a recession, you should start to think about how and when the economy will recover, what sectors and companies will recover first and which companies are best placed to perform well.
Nevertheless, remember not to invest any money which you cannot afford to lose and make sure you have ample savings set aside before you think about entering the market.
External Sources
- National Bureau of Economic Research
- Office of National Statistics - GDP
- Office of National Statistics - Inflation
- The Bank of England - How High Will Inflation Go?
- House of Commons Library - Components of GDP
- Federal Reserve - FOMC Statement
- The Bank of England - Monetary Policy Summary
- Evening Standard - UK Economy Historic Recessions
- BBC - Job Vacancies Outpace Unemployment
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