How will the UK economy perform in 2025?
It is easy to paint a gloomy picture of the UK economy at the moment.
It has shown few signs of life since June and business surveys since October’s Budget have painted an incredibly bleak picture of the year ahead.
According to the British Chamber of Commerce, business confidence slumped to its lowest level since the mini-Budget at the end of last year. December’s PMI, meanwhile, showed firms were cutting jobs at the fastest pace in four years.
Still, consensus among economists is for the UK to notch annual growth of 1.3 per cent in 2025, up from 0.8 per cent this year.
While this would leave the UK some way off the US and Canada, it would still be the leader among major European economies (admittedly not stiff competition at the moment).
Why do economists expect momentum to pick up despite the cacophony of negative headlines?
First, consumers are in a good place. Real wages are rising and will continue to do so for much of next year, unless the labour market collapses. This will give households greater spending power.
It is true that households have been less willing to spend recently. Household saving rates have increased significantly since the pandemic, hitting 10 per cent in the middle of last year – up from nearer five per cent in the four years before the pandemic.
But, economists think that households will be more willing to splash the cash in 2025, as the shocks of the past few years fade into memory and as lower interest rates offer less of an incentive to save.
Indeed, most economists see an elevated savings rate as a potential tailwind to growth because consumers could always dip into their accumulated savings.
A second factor supporting the growth case is the prospect of lower interest rates. Despite the uptick at the end of the year, inflation has fallen much faster than anticipated.
It may prove slightly stickier than previously expected in the New Year, due to the Budget, but this is unlikely to be enough to prevent the Bank from cutting rates again.
While Andrew Bailey stuck to the gradualist script at the Bank of England’s last meeting, three members of the Monetary Policy Committee (MPC) called for another cut.
Many economists think the Bank could easily cut rates three or four times in 2025, which would provide a welcome stimulus to the economy.
And the economy will receive a further stimulus from the boost to government spending announced in the Budget.
Public sector spending is set to increase by £70bn for the next five years from 2025/26. The Office for Budget Responsibility (OBR) suggests this could boost real GDP by 0.6 per cent from next year.
This relatively optimistic scenario is fragile though, and there are a few clear risks. Most obviously, it is still unclear how firms will react to the national insurance hike.
The scenario outlined above relies on inflation slowly coming back under control even as consumer demand strengthens; a delicate balance. The consensus view is essentially that the tax hike will not fundamentally damage this balance, even if the details are different.
Yes inflation will be a bit higher than it otherwise would have been, but not that much. And while activity in the private sector might slow, higher public spending will more than make up for it in the short term and help to get public services back on track in the longer term.
But if the government has underestimated underlying price pressures, then the Bank may be forced to delay its interest rate cuts. Alternatively, the labour market may already be buckling under the pressure of high interest rates. Higher labour costs could push it to breaking point.
There’s also no guarantee that higher government spending will provide as big a boost as organisations like the OBR anticipate.
Then, of course, there’s the potential for Donald Trump to upend the entire global trading system, which would certainly have a negative impact on growth (but might contribute to lower inflation).
In other words, the base case for the UK economy remains positive in 2025, but the risks are definitely tilted to the downside.