What is your outlook for the UK economy?
I don’t think it is as bad as some of the headlines might suggest. That said, it has been a tough start to the year for the UK economy, but I believe 2025 will turn out to be a better year for the economy than 2024. Businesses are not in a happy place and they’re going to have to deal with the reality of tax hikes come April. So, I’m not expecting much from the business sector this year, but I do think other parts of the economy will do better. Real household incomes are rising, so spending should increase, while the Chancellor did increase government spending and investment, which will support the economy. Where the Budget is going to squeeze one part of the economy, namely businesses, it will allow other parts of the economy to grow. This could mean that GDP growth of 0.8 per cent last year is replaced by something around 1.3 per cent this year. Not fantastic, but better than most people probably realise.
Do you think the Chancellor will be forced to roll back some of the measures she made in the Budget?
Our own calculation suggests that if government bond yields stay at current levels, the Chancellor will break her fiscal rule. To prevent that from happening, she’ll have to either trim government spending or raise taxes. I suspect in the next fiscal update on 26 March, spending is the one that is going to give. Raising taxes is politically unpalatable, so it is more likely that she will decide that the government just won’t spend as much over the next five years. We’ll probably see some fiscal jiggery pokery but the bottom line is that this will be an extra headwind to the economy; if fiscal policy is tighter, the economy can’t grow quite as fast.
Do you think the measures in the Budget will improve the UK’s productivity?
One of the big elements of the Budget was increased government spending – and if you spend more on public services, that’s unlikely to increase productivity. However, there was one element in the Budget that was encouraging and that was the big increases in public investment. One of the reasons for the UK’s low productivity growth rates over the past 20 years or so is that there hasn’t been enough investment in the public or the private sector. The trick here is that you can’t just say you’re going to spend that money and it magically improves productivity. You’ve got to spend it effectively on projects that make a difference to households and businesses. That’s never guaranteed.
What is your outlook for inflation?
Inflation came in at 2.6 per cent, above the 2 per cent target but not a disaster by any means – the Bank of England doesn’t have to explain itself to the Governor unless inflation is above 3 per cent or below 1 per cent. But the problem is that some parts of inflation are worse than others, particularly ‘services’ inflation, which is the best measure of domestic inflation. That is still at 5 per cent and is uncomfortably above the 2 per cent target. We need to see some progress here. But on headline CPI inflation, I still think we will end the year at about 2.5 per cent.
What is your outlook for interest rates?
It’s clear the current level of interest rates is restraining growth. Equally, inflation remains sticky. The Bank of England will need to tread a fine line. I suspect it should cut interest rates a little and gradually, to relieve some of the restraint on economic growth, but not too far or too quickly to reignite inflation. I think it will be a year when the Bank of England moves fairly slowly. It will likely cut rates four times, so maybe 25 basis points every quarter, which will take interest rates from 4.75 per cent now to 3.75 per cent, with another cut in 2026 to take them to 3.5 per cent.
Are we in a better place than three years ago?
It is worth putting where we are into context. A couple of years or so ago, we had this situation where the war in Ukraine had started, energy prices went through the roof, and everyone expected a deep and painful recession. Instead of having a short, sharp recession, we’ve had an elongated period of weak growth or stagnation. I believe this is the better outcome because you get less economic pain and it doesn’t cause people to suddenly lose their jobs. So, I don’t think we’re in a terrible situation. Indeed, there are reasons to believe that the outlook is going to improve over time when the effect of higher interest rates fades and the UK economy starts to strengthen.
What other risks do you see from an incoming Trump administration?
It is a given that Trump will extend the tax cuts he put in place in his first term as President. There’s a big assumption that he’ll go further and put in place another big fiscal stimulus by cutting taxes for businesses or households. The assumption is this will go some way to supporting and boosting economic growth, setting the tone for the rest of the world. We’re not convinced that’s going to happen. The situation is so much different than it was in Trump’s first term. US government debt is much higher, its deficit is much higher and interest rates are much higher. We don’t think there is going to be another big fiscal stimulus – and if we are right, you are not going to get that burst of economic growth that many are expecting.
Can you summarise where the UK is in the world economy?
We see the UK sandwiched between the US and Europe. Growth will not be quite as fast as the US, but not as weak as Europe. In an absolute sense, economic growth of 1.3 per cent is the best the UK can hope for. In all honesty, if I’m wrong, it is probably a little bit slower, rather than a little bit faster.
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