Key Takeaways
- Optimism in the UK’s economic prospects has declined in recent months. Bad weather and a rise in domestic energy bills are partly to blame but the recent Budget has played a major role.
- Labour-intensive sectors of the economy will face the burden of higher employer national insurance costs and a rise in the minimum wage.
- Unemployment will likely rise but there are some positives. Inflation has edged higher but remains below wage growth so real incomes will rise a little in 2025.
- Consumers are saving a healthy proportion of their savings, and the housing market is recovering. The Bank of England has suggested around 1% in rate cuts in 2025.
- On balance, we expect sluggish growth in 2025 but believe that the UK will avoid recession.
There has been a major decline in optimism about UK economic prospects in recent months. Surveys of business and consumer confidence have reversed their upward trends and GDP, which had been accelerating in the first half of the year, slowed to a crawl in the most recent quarter. The latest recruitment survey suggests that employment weakened markedly in November. Bad weather and the 10% rise in household energy bills in October are partly to blame but the Budget and other decisions by the new Labour government have undoubtedly played a major role.
This week, we look into 2025 and attempt to gauge the severity of problems facing the UK.
Let’s start with the Budget. Having ruled out raising revenue from the major sources of tax, the Chancellor Rachel Reeves decided to raise a whopping £25bn from employers’ national insurance contributions. Taxes will rise in other areas too. Public expenditure is set to be boosted over the next two years. Combined with a 6.7% rise in the minimum wage (17% for some younger workers) and plans to increase workers’ rights, the new government has placed an enormous burden on the labour-intensive sectors of the economy. Although some leading forecasters have suggested that the Budget was stimulative with the boost from public spending offsetting the drag from higher taxes, even they believe that the effect will be only temporary, and many other analysts are more uniformly negative.
The outlook is undoubtedly worrying. There will almost certainly be a rise in unemployment as employers scale back on recruitment and many low-margin labour intensive firms go out of business. However, before we get too pessimistic, it is worth noting some positives. First, although inflation is edging higher, it remains relatively low and below wage growth. So real incomes are set to rise a little in 2025. Second, consumers are already saving a healthy proportion of their incomes, so are well placed to increase spending. Third, the housing market is staging a recovery and swap rates, which determine mortgage rates have reversed much of the increases seen in the run up to the Budget. Although the Budget will have raised inflation, the Bank of England are still likely to cut rates – the Governor has suggested we might get a full 1% of cuts next year. Finally, the Chancellor retained the generous investment allowances introduced by the previous government and promised not to raise corporation tax in the rest of the parliament.
All in all, we think that the UK will avoid recession in 2025 but growth will be distinctly sluggish and accompanied by a noticeable rise in unemployment. The Treasury is undoubtedly rattled by the reaction to the Budget and is rumoured to be planning to ‘reprofile’ some of the bigger increases in planned government spending. The Budget did little to achieve their goal of securing a lasting improvement in UK growth. To do that, they must implement reforms. Top of the list should be an attempt to bring the ballooning bill for health and disability benefits under control. It is set to rise to £100bn by 2028, equivalent to almost £4,000 for every household in the UK. If they can do that, it would improve the public finances, increase labour supply and boost economic growth. Let’s hope they succeed.
Our next Market Perspectives update will be on Monday 6 January.
