Economic Outlook for 2025: Key Trends to Watch

As we enter 2025, the UK economy is navigating through a complex landscape, marked by ongoing inflationary pressures, slowing growth, and heightened global uncertainties. The latter part of 2024 revealed significant economic challenges, but there are reasons for cautious optimism as we look ahead. Economic policies, particularly increased government spending, could spur some growth, but several key factors will determine whether the UK can avoid stagnation and emerge with stronger momentum in the coming year.

Slowing Economic Growth at the End of 2024

The UK economy entered the final months of 2024 on a weak footing, with revised figures revealing that there was no economic growth in the third quarter. This performance ranked the UK as one of the worst-performing G7 economies during that period. The economy also contracted by 0.1% in October, marking the first instance of consecutive monthly GDP declines since the initial COVID-19 lockdown in March 2020. The downturn was primarily attributed to weak consumer demand, rising energy prices, and underperformance in key industries such as retail, hospitality, and energy extraction.

However, certain sectors showed resilience amid the overall slowdown. Professional services, such as law and accountancy, saw increased demand, driven by heightened activity ahead of the Autumn Budget. While these sectors provided some offset to the broader decline, the economy’s overall performance remained lacklustre, leaving many businesses and households bracing for a challenging 2025.

Inflationary Pressures Continue to Rise

Inflation has remained stubbornly high, contributing to the UK’s economic challenges. By November 2024, the Consumer Price Index (CPI) inflation had risen to 2.6%, marking the highest level since earlier in the year. The primary drivers of this inflation surge were higher fuel costs and clothing prices, although a notable drop in airfares helped to partially offset the increases. Despite the inflation uptick, the Bank of England decided to maintain interest rates at 4.75%, although there was significant debate within the Monetary Policy Committee. A split vote hinted at the possibility of an interest rate cut in the near future, with February 2025 looking like a likely time for action.

Looking forward, inflation is expected to fluctuate, with energy prices and global supply chain issues continuing to place upward pressure on costs. However, as inflationary forces begin to moderate, some relief could materialize later in 2025, especially if wage growth slows down and demand for services weakens.

A Slight Economic Rebound

Government Spending to Support Growth. While the end of 2024 was disappointing, there are reasons to expect some improvement in 2025. A key driver of this anticipated recovery is the government’s decision to ramp up public spending, much of which was announced in the October budget. This boost in spending, particularly on infrastructure and public sector services, is expected to provide a temporary economic boost. Increased public sector investment could help support consumer demand, bolster job creation, and foster a modest recovery in economic activity.

However, this government spending is likely to provide only short-term relief. The UK will face significant challenges in sustaining this growth, especially with looming tax hikes and the ongoing uncertainty in global markets. Retail and hospitality sectors, which are particularly sensitive to inflation and rising business costs, may continue to struggle in 2025. Higher insolvencies in these industries are expected as businesses grapple with rising operating costs, such as the planned increase in national insurance contributions in April 2025.

Inflationary Volatility Expected in 2025

As the year progresses, inflation is set to experience continued volatility. In the short term, rising energy costs and the fiscal impacts of the government’s budget are expected to push inflation above 3% by mid-2025. However, inflation should gradually ease in the latter half of the year, especially as wage growth slows and the pressure on service sector prices reduces. While the UK’s inflation rate could remain high compared to historical averages, the expected downward shift toward the end of 2025 should offer some breathing room for consumers and businesses alike.

Despite this potential relief, the persistence of inflation will remain a key challenge for policymakers. The Bank of England will need to carefully manage the trade-off between encouraging economic growth through lower interest rates and addressing the ongoing inflationary risks that threaten to undermine recovery. With inflationary pressures continuing to simmer, interest rates are likely to see slow and steady cuts, likely reducing from 4.75% to around 3.75% or 4.00% by the end of 2025.

Households and Living Standards: No Immediate Relief

For households across the UK, there is little sign of immediate relief from the financial pressures of rising living costs. Despite modest improvements in real wages and public services, many households will continue to struggle with high energy prices, food costs, and other essentials. These persistent cost-of-living challenges, compounded by inflation, are likely to prevent any substantial improvement in overall living standards.

Moreover, low productivity growth remains a significant barrier to achieving sustained wage increases and better living standards. Without addressing the UK’s longstanding productivity issues, any wage gains are unlikely to be substantial enough to offset the rise in household costs. As a result, the broader public may not feel the positive impacts of any economic recovery, making it unlikely that the UK will see a material improvement in living standards in 2025.

Global Factors: Uncertainty and Price Volatility

Looking beyond the UK, global factors are likely to play a key role in shaping economic conditions in 2025. The political and economic ramifications of potential changes in U.S. leadership, particularly under a new Trump administration, could significantly impact trade policies and global supply chains. The introduction of new tariffs could lead to higher global prices, further fuelling inflation in the UK and other economies. Additionally, Europe faces its own set of challenges, including political uncertainty in key economies like France and Germany, which could further weaken the continent’s economic performance.

In Asia, the success of China’s stimulus measures will be closely watched. The Chinese government’s ability to stabilize its property market and stimulate consumer confidence will have wide-reaching effects on global growth. If China’s economy fails to recover, it could drag down global growth expectations, which would be particularly detrimental for the UK’s export-driven sectors.

What to Watch for in 2025

As 2025 unfolds, key economic indicators will provide critical insights into the trajectory of the UK economy. Monthly GDP data, inflation figures, and business confidence surveys will be important signals to track. Economic data from major trading partners, particularly the U.S. and China, will also be crucial in gauging global market conditions and how they impact the UK.

In summary, the UK economy faces a challenging 2025, with inflationary pressures, a weak global economy, and slow growth in key sectors. However, government spending is expected to provide a short-term boost, and inflation could ease later in the year. The long-term success of the UK’s recovery will depend on tackling productivity issues and managing the delicate balance between inflation, interest rates, and economic growth. For now, 2025 will be a year of navigating these uncertainties while hoping for brighter prospects in the months to come.

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