What is a recession, are we heading towards one and what it means for | Personal Finance | Finance

Global stock markets dropped sharply on Monday amid rising fears that the US could be heading toward a recession. Japan’s Nikkei fell by nearly 13 percent today following weak US jobs data released last week.

The UK’s FTSE 100 also dropped more than two percent shortly after the markets opened, with the FTSE 250 falling more than three percent.

Other European exchanges, including those in France, Portugal, and Spain, saw similar declines, while Germany’s Dax decreased by one percent. These widespread losses are sparking some fears of a global crisis, due to “interconnected” world economies.

Nigel Green CEO of deVere Group said: “The [US Federal Reserve] is facing criticism for its handling of interest rates. Initially, it was slow to raise rates to combat inflation, and now, as economic growth slows, there are fears it’s moving too slowly to cut them. This has created uncertainty, making markets jittery and raising fears of a recession.”

However, he added: “But there could also be another trigger for a global market sell-off: Japan, the world’s third-largest economy.”

Mr Green explained that the Japanese yen has surged by about eight percent against the US dollar recently, reversing its decline from early July when it was at its weakest since December 1986.

This rise in the yen is problematic for the ‘carry trade’ strategy, where investors borrow in low-interest currencies like the yen to invest in higher-yielding ones like the US dollar, leading to a rapid sell-off in US equities as the cost of maintaining these trades increases.

Mr Green added: “This shift highlights the vulnerability of US markets to changes in global financial dynamics. The drop in US stock prices as the yen strengthens is a clear indicator of how interconnected global economies have become.”

But what could this mean for the UK? Could a knock-on effect lead to a recession at some point here? Express Money spoke to experts to find out.

A recession is defined as a prolonged period of decline in an economy.

Professor Marco Mongiello, pro vice-chancellor for business and science at The University of Law told Express.co.uk : “Typically, this is measured by negative growth of GDP (Gross Domestic Product).

“A typical threshold used to identify the start of a recession is when the GDP declines for two quarters in a row.”

While the wealth effect from falling share prices can lead to reduced consumer confidence in the short term, as investors may pause big-ticket purchases ahead of more clarity about where their investments will settle, Lindsay James, investment strategist at Quilter Investors told Express.co.uk: “The price moves themselves don’t typically lead to recession on their own.”

She explained: “The fact that in the UK, wages are continuing to rise well ahead of headline inflation is a more meaningful driver of consumer spending, at a time when interest rates are now being cut.”

Professor Mongiello said: “Although stock market trends are linked to overall economic growth or lack thereof, they are not an indicator nor a predictor of recession.

“Currently, markets in the UK and abroad are heavily affected by the existing conflicts in Europe and the Middle East and the uncertainty of further conflicts. Their effects on the expected prices of natural resources and reliability of supply chains keep giving micro-shocks to the market, which have cancelled each other.”

Rajan Lakhani, personal finance expert at smart money app Plum, added: “While there is a relationship between the stock market and economy, the state of the stock market does not in itself determine the state of the economy but does influence it.

“For example, it impacts consumer confidence and financial conditions, such as how much it costs for companies to borrow or secure funds. It can be a helpful predictor of future economic trends as shares are typically priced on expectations of company growth.”

The UK fell into a technical recession at the end of 2023. The economy shrank by 0.1 percent in the third quarter of 2023, then by a further 0.3 percent in the final three months of the year.

But in the period between January and March 2024, the economy grew by 0.6 percent, pulling the country out of the recession. Mr Lakhani said: “The latest figures from the ONS show we grew by another 0.7 percent in the period April to June 2024.”

However, Mr Lakhani noted: “It’s likely that inflation will rise again later in the year, which will put increased pressure on what people can afford and potentially slow growth. This would usually impact company sales, so they have less money to invest in their companies or return to shareholders, hitting economic performance.

“In advance of this, the Bank of England has cut the base rate slightly, which should relieve some pressure. It’s hard to predict whether or not another recession is on the cards as it depends on a great number of factors, both internal and external to the UK. But what’s for sure is that growth is a big priority of the new UK Chancellor, so we’re likely to see measures announced around this in the upcoming Autumn statement.”

Ms James added: “As the market is forward looking, it can be a signal that the global economy is weakening, to the extent that the risk of a US recession is rising. That is a reasonable assessment of the US, although the risk of recession in the next year still remains low.”

In regards to a recession, Professor Mongiello said: “The meaning for people is that there is less abundance of products available and less chances of increase in disposable income, often accompanied by sustained inflation.”

When referring to current stock market trends, Professor Mongiello said: “The meaning for people is, at the moment, negligible because their investments (if any) in the stock market are typically done through pension funds or other management funds, which are perfectly able to absorb these minor up and down adjustments.”