UK economic outlook: quarterly growth stalls but annual growth remains positive

Executive summary

• UK growth has probably bottomed out, but the road to recovery will be slow with some headwinds
• In Q3, the UK's quarter-on-quarter growth stalled, but the year-on-year (YoY) figures still paint a positive picture
• Consensus expects UK GDP to rise to 1.8% YoY by the end of Q4 2024, and to remain at around 1.5% throughout 2025
• Shorter term fiscal consolidation to pay off with increased investment long term

Growth

UK growth has probably bottomed out but the road to recovery will be slow. In the third quarter, the UK's quarter-on-quarter growth stalled, but the year-on-year (YoY) figures still paint a positive picture.

Similar to trends seen across Europe, the UK is expected to experience a cyclical upswing in the short term. Consensus expects UK gross domestic product (GDP) to rise to 1.8% for the full year 2024, and to remain at around 1.5% throughout 2025. While the numbers aren’t through the ceiling, it’s an improvement on previous years and shows an economy that’s heading in the right direction.

Source: Bloomberg.

The chancellor’s Autumn Budget introduced some major changes to the UK’s public finances. This has added some uncertainty and further negative sentiment towards the UK, which we think is overdone.

It’s still unknown how businesses will react to the increase in national insurance contributions. Attempts to pass on costs could cause a larger rebound in inflation, while reductions in wages or employment could undermine growth in consumer spending.Either way, the impact will be felt for low paid workers and the businesses employing them.

Wages in the UK continue to outpace inflation , and access to credit remains healthy. However, retail sales are flatlining despite modest improvements. Several factors are likely to dampen consumer recovery over the next year. The inflation spike post pandemic has had a damaging effect, reducing household balance sheets and leading consumers to adopt a more cautious approach moving forwards. The impact of interest rate rises, particularly through higher mortgage rates are still being felt, as well as contributing to upward pressure on rentals.

Business investment is gradually recovering from the post-Brexit slump, thanks in part to past policies like super-deductions and greater policy clarity moving forward. However, the outlook remains uncertain due to high financing costs and the looming risk of trade wars.

Purchasing Managers' Indices (PMIs) indicate a slowing growth momentum. While the PMI for services has dipped, this might be an overreaction to recent political developments. The fundamentals of the services sector remain relatively solid. The manufacturing sector is still struggling to gain the momentum needed for a full recovery. Industrial production has yet to reach pre-crisis levels, indicating ongoing challenges in this sector.

The labour market is stabilising, with vacancies falling from post-COVID highs. Wages are higher than pre-COVID averages but are steadying at relatively healthy levels. However, there is significant uncertainty about the numbers published by the Office for National Statistics (ONS) due to ongoing survey issues.

Looking longer term, the UK still faces structural problems and lacks an engine for sustainable growth. The medium- to long-term growth of the UK economy will hinge on two main factors: increased investment and sustained consumption on the one hand, and the fiscal drag on the other.

Increased spending on public services and investment

Over the next five years, the UK government plans to increase spending on public services and investment. While infrastructure investments are expected to yield benefits, these are likely to materialise only after the current parliamentary term ends. Productivity gains in public services are also unlikely to be realised until late in the term, if at all.

Further tax increases are anticipated, as some of the assumptions used by the Treasury appear overly optimistic. However, there are many avenues left to explore if the Labour government is going to stay true to its word by not increasing taxes on “working people”.

Recent tax rises could place additional burdens on businesses and individuals, potentially dampening economic growth. The longer-term impacts of the recent budget announcements are expected to be flat to negative for growth over the forecast horizon.

Inflation reacceleration likely

The headline CPI inflation is currently around the target of 2% but is expected to reaccelerate slightly next year due to base effects (inflation being lower than a year ago) and other headwinds.Overall, inflation should remain close to the target (averaging between 2.00% and 2.50%) throughout 2025, with risks leaning towards the upside.

Source: Bloomberg.

Energy prices are expected to come under some pressure in the near future with geopolitical tensions in Russia or the Middle East continuing to escalate and oil prices edging higher as a result.

The more important metric, core inflation, remains persistently high, primarily driven by the services sector. Inflation in the services sector is proving particularly stubborn, driven by the hospitality and culture. Wage demands and the current acceptance of price hikes by consumers mean that it will take some time for this inflation to subside.

The potential impact of a trade war remains uncertain. Tariffs imposed by the new Trump administration are likely to be inflationary, resulting in a strong US dollar and further upward pressure to UK inflation.

UK interest rates

The Bank of England (BoE) has initiated a cycle of interest rate cuts, although the exact pace of these cuts remains uncertain. Current market expectations appear to be realistic with the implied base rate at around 4.00% by mid-2025. But the BoE may be prompted to implement further cuts depending on global economic developments such as policy direction change in the US.