Chancellor Rachel Reeves got here to workplace in July pledging to toughen progress the primary mission of the brand new Labour authorities. Official figures on Friday underlined how far she is from reaching this ambition.
After gaining momentum since 2023, output slipped back in September and October. The figures verify that companies and households shied away from spending within the lead-up to a Funds that Prime Minister Sir Keir Starmer warned could be painful.
The newest figures are “a major disappointment”, based on Allan Monks at JPMorgan. However what are the important thing drivers behind the UK’s weak financial efficiency?
Pre-Funds nervousness
Reeves and Starmer made it abundantly clear their first Funds could be a troublesome one, warning of the necessity to appropriate a £22bn in-year overspend inherited from Rishi Sunak’s authorities and to lift funds to repair struggling public providers.
The prolonged interval of uncertainty earlier than October’s Funds damped confidence as companies and households awaited readability on tax and spending measures.
“Progress suffered within the run-up to the Funds, maybe as worries about greater taxation triggered households and corporations to postpone spending choices,” mentioned Andrew Wishart, economist at Capital Economics.
The UK’s poor efficiency within the second half of the 12 months contrasted with early 2024, when the financial system rebounded with 0.7 per cent progress within the first quarter, following a technical recession on the finish of final 12 months.
The fourth quarter of the 12 months might additionally show weak, as companies come to phrases with the higher tax burden introduced on the Funds, added Yael Selfin, chief economist on the consultancy KPMG UK.
Nonetheless, some economists play down the argument that the October slowdown was primarily pushed by pre-Funds jitters.
Chris Hare, economist at HSBC, mentioned the UK could also be topic to a low progress “pace restrict” due to weak productiveness. Annual UK productiveness progress has averaged solely 0.5 per cent over the previous 15 years, he famous. “If that productiveness difficulty doesn’t get higher, the financial system will solely have the ability to develop so quick.”
Financial institution of England warning
The Financial institution of England has trimmed rates of interest twice this 12 months, bringing them to 4.75 per cent, however the burden of excessive borrowing prices is constant to take its toll on the financial system.
Latest evaluation from the BoE confirmed that about half of mortgage holders, or 4.4mn households, should refinance their dwelling loans on to greater charges as soon as their mounted offers expire within the subsequent three years.
The BoE is predicted to depart rates of interest unchanged subsequent week, earlier than trimming them once more in the new year.
It has been reluctant to chop extra aggressively given persistently excessive services inflation. Economists polled by Reuters anticipate official figures subsequent week to point out providers worth progress of 5.1 per cent in November, in contrast with 5 per cent in October.
Uncertainty over how the Funds enhance in employer nationwide insurance coverage contributions will play out can be hampering BoE decision-making.
A survey revealed on Friday by the BoE confirmed that buyers now anticipate inflation of three per cent within the 12 months forward, up from 2.7 per cent when the query was final requested in August. It will add to the financial institution’s reluctance to hurry by additional charge cuts.
Some economists argue that indicators of a weakening jobs market imply the BoE will not be being aggressive sufficient in decreasing charges.
“A mixture of lingering inflationary aversion, alongside the particular sample across the providers inflation information, add to the danger coverage stays cautious for longer than it ought to,” mentioned Ben Nabarro, UK economist at Citigroup, in a notice this week.
Poor client confidence
Whereas inflation has subsided since highs exceeding 11 per cent in 2022 and actual incomes have been rising for greater than a 12 months, considerations about the price of dwelling are nonetheless restraining progress.
Family financial savings relative to disposable earnings have elevated this 12 months within the UK and the Eurozone, underscoring an image of cautious shoppers.
“There’s a danger that family financial savings charges will proceed to rise, which might act as a major drag on progress,” HSBC’s Hare mentioned.
Output in consumer-facing industries, comparable to bars and eating places, was nonetheless 5.3 per cent beneath its pre-pandemic ranges in October, reflecting decrease spending as family funds have been hit by elevated costs and borrowing prices.
European malaise
The poor well being of the broader European financial system can be holding the UK again, given the EU is the nation’s greatest export market.
The Eurozone grew by simply 0.4 per cent within the third quarter, up from 0.2 per cent within the earlier three months.
European economies are lagging behind the US, the place the financial system is 11.4 per cent above its pre-pandemic degree, in contrast with 3 per cent within the UK and 4.6 per cent within the Eurozone.
The chance of worsening commerce tensions within the new 12 months, when Donald Trump takes energy within the US, might act as an added drag on European economies.
“A weakening export local weather amid rising international coverage uncertainties and declining enterprise confidence, exacerbated by the affect of just lately introduced Funds measures, raises considerations about sustaining the expansion momentum,” mentioned Hailey Low, economist on the Nationwide Institute of Financial and Social Analysis.
Murky prospects
October’s weak GDP figures increase questions on progress forecasts for subsequent 12 months. In October, the Workplace for Funds Duty forecast progress of two per cent in 2025, up from 1.1 per cent this 12 months.
Analysts at the moment are revising down their expectations. Economists polled by Consensus Economics on December 9 anticipated progress of 0.9 per cent this 12 months and 1.25 per cent in 2025. Following Friday’s information, Capital Economics downgraded its 2025 progress forecast to 1.4 per cent from 1.6 per cent.
Even when that gloomier prognosis bears out, it nonetheless means subsequent 12 months will likely be modestly stronger than 2024, nevertheless. That’s partially as a result of the federal government’s Funds boosted borrowing and spending, which ought to assist financial exercise.
“The outlook for the UK financial system subsequent 12 months, relative to the G7, stays brighter,” mentioned Barret Kupelian, chief economist at PwC UK.
