Fragile Growth and Trade Tensions: The UK’s Spring Economic Challenge

Since our Winter 2025 Economic Outlook, we have seen significant political and economic policy announcements globally and domestically. What is your current outlook for UK growth in 2025?

Since we published our Winter UK Economic Outlook in February, the global and domestic economic landscape has shifted considerably. In the first half of 2024, the UK economy grew more strongly than expected, though this tapered off in the second half of 2024. However, emerging risks and ongoing uncertainties now cast a shadow over the outlook for 2025.

We seem to be entering a new phase for the global economy marked by arbitrary protectionist announcements and fragmented trade relationships. Recent actions by the United States, particularly the “Liberation Day” announcements and the ongoing tariffs on China, have revealed broader risks in the global trading environment.

The United Kingdom currently faces a 10 per cent base tariff rate on goods. While this is less damaging for us than for our nearby trading partners in Europe, given that the bulk of our trade with the United States is in services, it still raises concerns. Weaker external demand and increased volatility in global trade flows are likely to negatively impact the United Kingdom’s export-dependent sectors, such as manufacturing and wholesale trade, where business surveys have already flagged the decline in export volume. Additionally, the services sector may encounter challenges as global uncertainty and subdued consumer sentiment dampen activity.

Domestically, we are experiencing cost pressures materialising. The recent rise in employer National Insurance contributions and the increase in the National Living Wage, effective since the beginning of April, will raise business costs this year. These pressures will impact hiring decisions, input costs, profit margins, and investment. Furthermore, rising energy bills, council tax, and water bills will reduce households’ real personal disposable income. With consumer and business sentiments remaining fragile, the cumulative impact risks further slowing economic momentum.

While the risk of recession remains low under current conditions, the chances of achieving robust and sustained growth seem increasingly remote. Without substantial policies to boost productivity and stimulate business investment, the United Kingdom risks being on a low-growth trend for the foreseeable future.

Global and domestic developments have likely influenced the trajectory of interest rates and inflation this year. What is the outlook for inflation in 2025?

Since we published our Winter UK Economic Outlook, forecasting inflation and interest rates has become more complex, influenced by a turbulent global environment. The good news is that headline inflation in the United Kingdom continued to decline, with the latest annual reading at 2.6 per cent in March, down 0.2 percentage points from February. However, our progress toward the 2 per cent target has stalled, and we are likely to see a jump in inflation in April, reflecting the impact of regulated price increases, such as energy and water bills, and council tax, which rose sharply in April. These price pressures are squeezing household budgets and are likely to delay the pace of interest rate cuts. Looking further forward, we expect inflation to fall back to target more slowly than previously projected due to domestic cost pressures and loose fiscal policy.

While there is a possibility that global trade fragmentation could redirect cheaper goods towards the United Kingdom, particularly as surplus products are diverted from the United States, this effect may be outweighed by the broader inflationary impact of tariffs. Tariffs act as a negative supply shock, raising business input costs and ultimately pushing up prices as supply chains are disrupted.

As a result of the greater inflationary pressures we now see, while financial markets initially expected a steady pace of Bank of England rate cuts through 2025, the outlook for monetary policy has become tighter. Interest rate cuts are still likely, but at a more measured pace, as the Bank balances the need to support economic growth with the risk that inflation remains stickier than expected.

In short, while some global forces may provide limited disinflationary relief, domestic cost pressures mean that the path back to target inflation will be slower and more uneven. Monetary policy will remain constrained by the trade-off between securing price stability and supporting a still-weak economic recovery.

Given high borrowing costs in the United Kingdom and limited fiscal headroom, what is the likely path of fiscal policy this year?

The Spring Statement on 26 March aimed to maintain economic credibility in the face of worsening global conditions. Higher-than-expected public sector borrowing and weaker-than-expected GDP growth have sharply eroded fiscal headroom. Public sector borrowing in February and March 2025 significantly overshot forecasts, and the £9.9 billion of fiscal headroom established at the October 2024 Budget had already turned into a £4.1 billion shortfall before the Chancellor’s revised measures were announced.

The Statement therefore sought to restore compliance with the government’s two primary fiscal rules: the ‘Stability Rule’—requiring the current budget to be in balance—and the ‘Investment Rule’—requiring public sector net financial liabilities to fall as a share of GDP. To rebuild headroom, the Chancellor announced £10 billions of savings, primarily by shifting spending from current expenditure (such as foreign aid) towards capital investment (such as defence) and tightening welfare eligibility. Housing market reforms were also presented as a medium-term measure to enhance growth and tax revenues.

Whilst it restored some headroom in the short term, it came primarily through cuts in spending, particularly reductions in welfare benefits and foreign aid. Coupled with  expected weaker growth, this places the Chancellor in a difficult position ahead of the Comprehensive Spending Review and Autumn Budget, where further cuts in public spending or tax increases cannot be ruled out if the government is to meet its self-imposed fiscal rules.

The combination of narrow fiscal headroom and historical forecast errors adds significantly to fiscal uncertainty. Firms and households are likely to remain cautious about investment and spending, especially given the heightened risk of future tax rises or additional spending cuts. While the Spring Statement achieved short-term compliance on paper, it did little to establish a credible medium- to long-term fiscal strategy. Instead, it reinforced the impression of short-term fiscal tinkering designed to manipulate the fiscal rules rather than promote sustained economic growth.

Given the limited fiscal headroom and mounting economic risks, we expect the path of fiscal policy for the remainder of 2025 to remain extremely constrained. Further tightening—whether through spending cuts or tax increases—cannot be ruled out in the next Autumn Budget. At a time when clarity and credibility are most needed to support confidence and investment, the current fiscal framework risks perpetuating uncertainty.