UK QUARTERLY ECONOMIC OUTLOOK | Q1 2025
Economic outlook
Tariff threat weighing on growth
We now expect growth to come in at just 1% this year, only a fraction better than last year, and well off any 2% ambitions. At the same time, with inflation likely to float up to almost 4%, the UK looks to be back in the grips of ‘stagflation’. Admittedly, things aren’t as bad as they seem at first glance. Growth should still improve throughout the year and the surge in inflation is likely to be temporary. But it now seems like we’ll have to wait until 2026 before a return to ‘normal’.
The domestic economy doesn’t look nearly as bad as some of the headline numbers suggest. Real household disposable income, which is the best measure of consumers' ability to spend, rose by over 4% in 2024. In aggregate terms, it is now about 6% above its pre-pandemic peak, putting households in a relatively strong financial position. However, this has not translated into higher consumer spending, which has only risen by a little over 1%. Households are prioritising saving over spending. Indeed, the saving ratio, which is the proportion of disposable income saved by consumers, has been above 10% for most of 2024, roughly the same as in 2009 in the wake of the Global Financial Crisis.
We expect real household disposable incomes to rise by around 1.5% this year and for the saving rate to gradually trend down as interest rates fall and consumer confidence recovers. This results in consumer spending growing by a little over 1% this year. But the risk is clearly that consumer confidence remains depressed and household saving remains elevated, which weighs on spending growth.
One bright spot should be government spending. The increase in spending and investment announced in the autumn budget will begin to filter through into the wider economy, providing a decent tailwind for the economy. However, some of this boost may be offset by lower business investment as firms grapple with increasing costs from the budget and rising energy prices.
We expect real household disposable incomes to rise by around 1.5% this year
The big headwind will continue to be the external sector. Growth in the EU and China, which account for roughly 50% of UK exports, has been weak and will continue to be this year, which will weigh on export growth. But the biggest risk comes from the potential tariffs. The UK runs a broadly balanced trade in goods with the US so may escape direct tariffs. However, a general increase in uncertainty and increase in tariffs elsewhere will still depress UK growth and raise inflation.
There are any number of tariff scenarios. For now, we have adopted a working assumption of a 10% US universal tariff, which has knocked 0.1% off our GDP forecast this year. But if we take Trump’s threat to impose reciprocal tariffs on all countries, including those that have a form of VAT, that would mean a 20% tariff on UK exports to the US. In that case, we estimate that 2% of GDP would be at risk of being impacted. The hit to growth would be at least 0.2% and probably even bigger, as higher tariffs can induce larger indirect effects.
But tariffs aren't the only risk.
But tariffs aren’t the only risk. The financial channel could prove to be a significant drag on growth this year. We’ve already seen rising treasury yields in the US push up gilt yields in the UK. 10-year gilt yields are now about 0.5 ppts higher than they were in September. The prospects of higher tariffs and tax cuts in the US, along with rising debt issuance in Europe to fund higher defence spending, could push up gilt yields in the UK, weighing on growth. At the same time, the pound is likely to remain weak against the dollar, which will put some upward pressure on inflation.
The upshot is that the domestic UK economy is in better shape than widely thought and should pick up steam this year as consumer and government spending push up growth. The risks are mainly stemming from the external sector, where weak international growth and the threat of tariffs are weighing on growth. Overall, we’re expecting growth of 1% this year and 1.5% in 2026.
Real GDP (Q/Q%)
