How much will the UK economy grow in 2025?
Interpreting the performance of the UK economy in 2024 has been a challenge.
At the beginning of the year, most forecasters expected that the UK would suffer another year of stagnation.
“Expectations were bleak coming into 2024,” Sanjay Raja, chief UK economist at Deutsche Bank, said. “External forecasters were projecting near zero per cent growth for the entire year.”
In fact, the economy saw a rapid rebound from the recession which closed out 2023. In the first quarter, the UK grew 0.7 per cent.
Across the first half of the year, the UK was among the fastest growing G7 economies in the world.
It was not to last.
Having been one of the fastest growing economies in the first half of the year, the economy has slowed significantly.
Figures out earlier this month showed that the economy contracted for a second consecutive month in October. Indeed, it has been more or less stagnant since June.
“The risk of a recession has suddenly become real,” Paul Dales, chief UK economist at Capital Economics said.
Thanks to the strong first half, the UK is still on track to grow 0.8 per cent this year. But what happened to the strong momentum seen earlier in the year?
What happened to the UK economy?
There are three overlapping factors.
The first is that a slowdown was always going to happen. That’s because the recovery from the start of the year was fuelled by ‘catch-up’ growth.
In 2023, the UK performed well short of its potential growth rate, meaning there was plenty of unfilled capacity. At the start of 2024, it bounced back.
Businesses were more confident in taking the decisions that might have been put on hold a few months ago. Households were more likely to spend a bit more, too. This was never going to last forever.
Still, the slowdown has been far more pronounced than many expected a few months ago.
Which brings us to the second factor: interest rates.
Market expectations for the path of interest rates – and, therefore, the cost of borrowing in the real economy – have changed a lot this year.
At the start of the year, markets expected around five rate cuts when, in fact, there have been only two.
This change in expectations has had an impact on activity. Analysis from Capital Economics suggests that the fastest-growing sectors earlier in the year were those with the highest sensitivity to changes in interest rates (i.e. those with the most to gain from rapid rate cuts).
As those rate cuts failed to materialise, activity slowed.
“Hopes at the start of this year that interest rates would fall rapidly have given way to the reality of rates being reduced only gradually,” Dales said.
There is, of course, a final factor. Policy.
Rachel Reeves must take some of the blame
The timing of the slowdown neatly aligns with Labour entering power and Rachel Reeves must take some of the blame.
Consumer and corporate confidence plummeted over the autumn amid warnings of a painful budget. Business surveys since the fiscal event have pointed to a continued slowdown, largely due to the increase to national insurance.
The private sector cut jobs at the fastest rate for nearly 4 years in December, according to S&P’s purchasing managers’ index (PMI).
“Businesses and households have responded negatively to the new Labour government’s downbeat rhetoric and policies,” Chris Williamson, chief business economist at S&P Global Market Intelligence said.
This hardly bodes well for next year. Still, economic forecasters expect the UK to grow 1.3 per cent in 2025, an acceleration on 2024.
The case for optimism rests on a few solid fundamentals. The labour market remains solid, helping to support strong wage growth even while inflation continues to fall.
Throw into this the general deleveraging of household balance sheets since the financial crisis, and UK consumers are not in a bad place.
Of course, a lot will depend on how firms respond to the national insurance hikes. There’s also a healthy dose of uncertainty to come from a second Trump presidency. But economists are not writing off the UK just yet.