UK QUARTERLY ECONOMIC OUTLOOK | Q2 2025
Economic outlook
Best is already behind us, but there is underlying strength
The gangbusters growth of Q1 is likely to mark the economic high point of 2025. We are now facing a hurricane of headwinds from tariffs, systemic uncertainty, higher taxes, a softening labour market and a slowdown in the global economy. All those factors will drag on growth this year and most likely into 2026 too.
However, there are some positives. Consumer spending has finally started to pick up and – so far at least – has remained resilient to tariff uncertainty. Lower interest rates and stronger government spending will also help to offset some of those headwinds.
All in all, this year is likely to feel similar to last, with growth a little over 1%. However, the risks both to the downside and upside are significantly larger.
All aboard the GDP rollercoaster
A chart of economic growth this year will look like a pretty good rollercoaster. After flatlining in the second half of last year, growth surged to 0.7% in Q1. Admittedly, growth in Q1 was flattered by firms and consumers bringing forward activity ahead of the imposition of tariffs and taxes in April. We estimate about half the growth in Q1 was due to this. That means there'll be some economic payback in Q2, which will probably drag growth down to 0.2%. However, risks are tilted to the downside and a contraction is not out of the question.
Softer growth ahead, but pockets of strength
Even once the volatility around tariffs is smoothed out, the economy is still left facing headwinds it did not have to endure in Q1. The 10% tariffs on most UK goods exports to the US looks likely to be permanent, which will weigh on UK exports to the US. More importantly, the extreme uncertainty around tariffs and the way they have been implemented mean consumer confidence and especially business sentiment will remain subdued for the foreseeable future, impacting business investment and consumer spending. A slowdown in global growth – the IMF has knocked 0.5ppts off its 2025 estimate of global growth – adds to this picture and will depress demand for UK exports. Finally, a higher tax burden and softening labour market will add to the headwinds already buffeting the domestic economy from here on out. Cumulatively, we think these factors will knock about 0.5% off GDP this year.
However, it’s not all doom and gloom. Real household disposable income, which is the best measure of consumers’ ability to spend, rose by 4% in 2024. In aggregate terms, it is now 7% above its pre-pandemic peak, putting households in a relatively strong financial position.
With real incomes set to rise by about 2% this year, despite inflation jumping to 3.5%, and the household saving ratio at 12% – about the same as in 2009 in the wake of the Global Financial Crisis – there is plenty of scope for consumers to save a bit less and spend a bit more, assuming, of course, that confidence continues to rebound. Indeed, as resilient consumer spending in April shows, there’s only so much that UK consumers care about US tariffs on China. Overall, we anticipate consumer spending growth of a little over 1% this year.
There’s only so much that UK consumers care about US tariffs on China
However, businesses will be hit hardest by the uncertainty generated by tariffs and the increase in taxes. This means we think business investment will be a bit softer this year than previously expected, but this will be partially offset by lower interest rates and higher government spending and investment.
The upshot is that the domestic UK economy is in better shape than widely thought. However, it will be battling some intense headwinds generated by US trade policy and domestic tax policy over the next 12 months. The risks mainly stem from the external sector where weak international growth and the threat of tariffs are weighing on growth. Overall, we’re expecting growth of 1.2% this year and 1.5% in 2026.
This all said, given the current heightened uncertainty, we have run illustrative downside and upside scenarios.
A downside scenario
An upside scenario
In our downside scenario, US tariffs on the rest of the world ramp up again after the 90-day pause. This would cause a renewed bout of uncertainty and volatility in financial markets. Here, the US slips into a recession and growth in the rest of the world slows sharply.
At the same time, strong UK domestic inflationary pressures from tax policy and potentially retaliatory tariffs prevent the Bank of England from cutting interest rates more aggressively to support the economy. In this case, the UK slips into a small recession this year and stagnates in 2026 before recovering in 2027.
In our upside scenario, the 90-day pause on most tariffs becomes permanent, allowing uncertainty to gradually diminish. At the same time, the US engages in fiscal stimulus, which helps to offset some slowing in global growth.
UK business sentiment and consumer confidence recover rapidly and inflation hovers around 3.5%, allowing the Bank of England to continue with gradual interest rate cuts. In this case, growth comes in at around 1.5% this year and 1.8% in 2026.
An upside scenario
In our upside scenario, the 90-day pause on most tariffs becomes permanent, allowing uncertainty to gradually diminish. At the same time, the US engages in fiscal stimulus, which helps to offset some slowing in global growth.
UK business sentiment and consumer confidence recover rapidly and inflation hovers around 3.5%, allowing the Bank of England to continue with gradual interest rate cuts. In this case, growth comes in at around 1.5% this year and 1.8% in 2026.
A downside scenario
In our downside scenario, US tariffs on the rest of the world ramp up again after the 90-day pause. This would cause a renewed bout of uncertainty and volatility in financial markets. Here, the US slips into a recession and growth in the rest of the world slows sharply.
At the same time, strong UK domestic inflationary pressures from tax policy and potentially retaliatory tariffs prevent the Bank of England from cutting interest rates more aggressively to support the economy. In this case, the UK slips into a small recession this year and stagnates in 2026 before recovering in 2027.
