Britain succumbed to its first economic contraction since the aftermath of the financial crisis, raising the stakes for Boris Johnson’s government as it seeks an imminent exit from the European Union.

The unexpected 0.2 per cent decline in gross domestic product during the second quarter -- the worst performance since 2012 -- provides a foretaste of the potential damage to growth that most economists are warning of if Brexit happens without any transition. The pound fell after the report, sliding to $1.2117 as of 10:17 a.m. in London.

The drop in output means the U.K. is in danger of falling into a technical recession with one more quarterly decline. It also highlights the predicament of the Bank of England, whose central forecasts see the need for gradual interest rate increases. Governor Mark Carney says the reaction to a no-deal Brexit, which would push down the pound and drive up inflation while further denting growth, could go in either direction.

“Underlying momentum remains lukewarm, choked by a combination of slower global growth and Brexit uncertainty,” said Alpesh Paleja, lead economist at the Confederation of British Industry. “As a result, business sentiment is dire.”

The abrupt drop came as many firms ran down inventories built up ahead of the original March 29 deadline to leave the European Union. Stock levels fell by 4.4 billion pounds ($5.3 billion), knocking 2.15 percentage points off GDP.

What our Economist Says:

“The U.K.’s GDP figures for the second-quarter made for dismal reading. But they probably exaggerate the loss of growth momentum since the start of the year. Part of the weakness reflects one-time factors that won’t be repeated. Growth is likely to return in 3Q albeit to unspectacular rates.” -- Dan Hanson, Bloomberg Economics

The economy was also hit by auto factories bringing forward summer maintenance shutdowns to April to avoid the threat of supply disruptions around the original Brexit deadline.

Manufacturing, which enjoyed a bumper first quarter, shrank 2.3% in the following three months, the most since 2009.

The GDP figures are the first since Johnson became premier last month, vowing to take Britain out of the EU by Oct. 31, with or without a deal to cushion the blow.

Johnson is pledging a fiscal boost to help the economy cope with Brexit. Investors are currently pricing in a 25-basis-point reduction in BOE interest rates for January 2020. The U.S. Federal Reserve has starting cutting rates and the European Central Bank has pledged more stimulus as soon as September.

“The global backdrop is certainly the big drag in terms of growth at the moment, and Brexit uncertainty weighing on business investment,” said George Brown, an economist at Investec Bank Plc. “‘There’s certainly an element of inventory overhang,” but surveys suggest “underlying growth is a lot weaker.”

Get More:

  • Household spending rose a stronger-than-forecast 0.5 per cent in the second quarter amid low unemployment and rising wage growth.
  • Business investment resumed its downward trend with a 0.5 per cent decline. It fell 1.6 per cent from a year earlier. Government spending rose 0.7 per cent, possibly boosted by spending on the health service.
  • In June alone, services stagnated for a fourth month; construction fell 0.7% as wet weather put projects on hold; and industrial output fell 0.1 per cent, with manufacturing slipping 0.2 per cent
  • The drag from stockpiling last quarter was offset by net trade, which added 3.5 percentage points to growth as the trade deficit narrowed sharply.
  • The total deficit including services was in surplus, but still in deficit when unspecified goods including non-monetary gold are excluded.