Chancellor Rachel Reeves got here to workplace in July pledging to reinforce development the primary mission of the brand new Labour authorities. Official figures on Friday underlined how far she is from attaining 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 can be painful.
The most recent figures are “a major disappointment”, in keeping with Allan Monks at JPMorgan. However what are the important thing drivers behind the UK’s weak financial efficiency?
Pre-Funds anxiousness
Reeves and Starmer made it abundantly clear their first Funds can be a tricky one, warning of the necessity to appropriate a £22bn in-year overspend inherited from Rishi Sunak’s authorities and to boost funds to repair struggling public companies.
The prolonged interval of uncertainty earlier than October’s Funds damped confidence as companies and households awaited readability on tax and spending measures.
“Development suffered within the run-up to the Funds, maybe as worries about greater taxation induced 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 yr contrasted with early 2024, when the financial system rebounded with 0.7 per cent development within the first quarter, following a technical recession on the finish of final yr.
The fourth quarter of the yr 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.
Nevertheless, 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 development “pace restrict” due to weak productiveness. Annual UK productiveness development has averaged solely 0.5 per cent over the previous 15 years, he famous. “If that productiveness challenge 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 yr, bringing them to 4.75 per cent, however the burden of excessive borrowing prices is continuous to take its toll on the financial system.
Latest evaluation from the BoE confirmed that about half of mortgage holders, or 4.4mn households, must refinance their residence loans on to greater charges as soon as their fastened offers expire within the subsequent three years.
The BoE is predicted to go away 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 companies value development 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 also 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 yr forward, up from 2.7 per cent when the query was final requested in August. This may add to the financial institution’s reluctance to hurry by way of additional charge cuts.
Some economists argue that indicators of a weakening jobs market imply the BoE just isn’t being aggressive sufficient in decreasing charges.
“A mix of lingering inflationary aversion, alongside the precise sample across the companies inflation knowledge, add to the danger coverage stays cautious for longer than it ought to,” mentioned Ben Nabarro, UK economist at Citigroup, in a observe 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 yr, considerations about the price of residing are nonetheless restraining development.
Family financial savings relative to disposable earnings have elevated this yr within the UK and the Eurozone, underscoring an image of cautious customers.
“There’s a threat that family financial savings charges will proceed to rise, which might act as a major drag on development,” HSBC’s Hare mentioned.
Output in consumer-facing industries, similar 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 also 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 yr, when Donald Trump takes energy within the US, might act as an added drag on European economies.
“A weakening export local weather amid rising world coverage uncertainties and declining enterprise confidence, exacerbated by the affect of 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 development forecasts for subsequent yr. In October, the Workplace for Funds Accountability forecast development of two per cent in 2025, up from 1.1 per cent this yr.
Analysts are actually revising down their expectations. Economists polled by Consensus Economics on December 9 anticipated development of 0.9 per cent this yr and 1.25 per cent in 2025. Following Friday’s knowledge, Capital Economics downgraded its 2025 development forecast to 1.4 per cent from 1.6 per cent.
Even when that gloomier prognosis bears out, it nonetheless means subsequent yr can be modestly stronger than 2024, nonetheless. That’s partly 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 yr, relative to the G7, stays brighter,” mentioned Barret Kupelian, chief economist at PwC UK.
