The economic landscape in the United Kingdom (UK) presents a complex picture characterised by modest growth expectations, persistent inflationary pressures, evolving fiscal policies and the threat of a recession.
Key themes for the week:
- The UK continues to face economic challenges
- US Treasury yields rebound, while UK Gilt yields fall
- Equities calm down following their positive reaction to Trump’s policies
- Oil and gold prices settle following threats of US sanctions on Russia and Trump’s tariffs
- Dollar dips on the back of weak US labour data
The International Monetary Fund projects that the UK’s gross domestic product (GDP) will grow by 1.6% in 2025 and 1.5% in 2026. This is up from a dismal 0.9% in 2024, which fell short of earlier predictions. The revised outlook reflects expectations of improved real incomes, increased consumption, and government fiscal measures aimed at bolstering public investment. Audit, tax and advisory firm, KPMG, offers a slightly more optimistic forecast, suggesting UK GDP growth could reach 1.7% in 2025, primarily driven by household consumption and government spending. However, this growth is expected to be temporary, spurred by significant fiscal expansion announced in the Autumn Budget.
Inflation and monetary policy
UK inflation remains a pressing issue. Forecasts indicate inflation will hover between 2% and 3% through 2025 and 2026. Contributing factors include higher National Insurance contributions and increased living wage levels, which businesses will likely pass on to consumers.
In response, the Bank of England (BoE) is expected to approach interest rate cuts cautiously, with gradual reductions possibly bringing the base rate to around 4% by the end of 2025. This strategy seeks to balance the economic stimulus promised in the Autum Budget with managing inflation expectations.
Labour market dynamics
The UK labour market is demonstrating resilience despite economic challenges. Real wage growth continues to support household spending, a critical driver of economic activity. However, businesses face higher costs due to increased labour expenses, which may dampen hiring and investment decisions. Potential declines in net migration could exacerbate labour shortages, complicating growth prospects across various sectors.
Financial market conditions
Financial markets have experienced recent volatility, driven by concerns over stagflation – stagnant growth coupled with elevated inflation. These fears have led to increased borrowing costs and currency fluctuations. However, easing inflationary pressures globally and domestically are beginning to stabilise markets.
In addition, yields on UK government bonds remain elevated, reflecting investor concerns about fiscal sustainability amid rising debt levels and geopolitical tensions. Such factors contribute to an uncertain investment climate, and potentially impact economic stability.
Manufacturing sector challenges
Sentiment in the UK manufacturing sector dropped sharply to -47 in January 2025, marking its steepest decline in over two years, according to the Confederation of British Industry. Manufacturing output decreased, and new orders fell, particularly for exports, which saw their steepest drop since 2020. Manufacturers anticipate these trends to worsen in the next quarter.
Increased cost pressures have been reported, with inflation in domestic and export prices expected to rise significantly. Investment intentions have deteriorated as manufacturers cut back on spending across all categories due to demand uncertainty, poor returns, and a lack of internal finance.
Employment prospects have also weakened, with hiring expected to decline at its fastest rate since July 2020. Many manufacturers express concerns that this negative sentiment could become self-fulfilling and are calling on the government to implement clearer policies to support the sector.
Fiscal policy implications
Fiscal policy plays a pivotal role in shaping economic outcomes. The UK’s recent Autumn Budget introduced measures to increase public sector investment to stimulate demand and support long-term growth. However, these measures are paired with higher taxes to finance the initiatives.
Rising borrowing costs have intensified scrutiny of fiscal policy, as yields on government bonds reflect broader global conditions and growing investor concerns about the UK’s economic outlook. These concerns have strained fiscal rules requiring day-to-day spending to be covered by revenues. Chancellor Rachel Reeves faces the challenge of maintaining compliance with these rules, especially as UK Gilt yields erode budgetary headroom.
The upcoming Spring Statement in March may reveal new measures, such as tax increases or spending adjustments, to address these pressures. The UK economy’s sluggish growth – evident in zero growth in the third quarter of 2024 and marginal growth of 0.1% in November – further compounds the challenges.
While increased public spending from the Autumn Budget seeks to stimulate activity, its immediate impact has been mixed, prompting debate about the efficacy of current strategies. Potential policy adjustments in March could shape fiscal direction moving forward.
Cautious optimism
The UK’s economic landscape in early 2025 is marked by cautious optimism amid persistent challenges. While growth projections suggest a recovery from 2024’s weaker performance, risks related to inflation, labour market constraints, and fiscal sustainability remain significant. Challenges in the manufacturing sector, alongside rising borrowing costs and strained fiscal rules, underscore the precarious nature of the UK’s recovery.
MARKET RECAP
Bonds
The United States (US) 10-year Treasury note yield rose above 4.62%, rebounding from a near three-week low of 4.58%. This increase reflects market reactions to President Trump’s recent policy announcements, including potential tariffs against several nations and plans for tax cuts, and artificial intelligence (AI) infrastructure investment. All of which could create inflationary pressures. Despite these developments, traders are still betting on a rate cut from the US Federal Reserve later this year, with expectations leaning towards a reduction in the third quarter.
In the UK, the 10-year Gilt yield decreased to below 4.65%, retreating from a recent high of 4.9%. This decline aligns with a global trend of falling bond yields, particularly after Trump decided against imposing tariffs on his inauguration day. However, he later indicated plans for a 25% levy on imports from Canada and Mexico starting 1 February 2025. The BoE is anticipated to lower key interest rate by 25 basis points to 4.5%, responding to rising unemployment, and wage growth that reached a six-month high.
South Africa’s 10-year government bond yield rose to its highest level since mid-January to slightly above 9.20%. Earlier this week, South African Reserve Bank (SARB) Governor, Lesetja Kganyago, cautioned that US protectionist policies could lead to higher inflation and complicate the local rates outlook.
Equities
In the equities market, US stock futures were relatively flat on Thursday, with the S&P 500 down 0.2% and the Nasdaq 100 declining by 0.5% following an earlier record-high session. Investors are taking a cautious approach after the initial excitement surrounding Trump’s pro-growth policies and AI investments. The earnings season continues to impact stock performance.
The UK’s FTSE 100 moved largely sideways after reaching record levels earlier in the week, reflecting growing concerns about consumer confidence amid recession fears. Notably, food ingredient and retail brand, AB Foods, adjusted its sales growth forecast downward due to weaker sales in the UK and Ireland, negatively impacting its stock price.
In Germany, the DAX index edged higher, surpassing 21,300, reaching a new all-time high, driven by mixed earnings results and the ongoing monitoring of Trump’s policies.
Commodities
Commodity markets are also reacting to geopolitical developments, and US policy in particular. Brent crude oil futures stabilised near $79/barrel, following an industry report that revealed the first rise in US crude stockpiles since mid-November. The American Petroleum Institute reported an increase of one million barrels in US crude inventories last week, raising concerns about supply dynamics as Indian refiners seek alternatives due to lost Russian supplies on the back of US sanctions.
The gold price eased slightly to around $2,750 per ounce, halting a three-day gain but remaining near its highest level since early November. The metal’s appeal as a safe haven has been bolstered by uncertainty surrounding Trump’s tariff plans and fears of trade wars.
Currencies
The US Dollar Index dipped to 108.2, influenced by rising unemployment claims and benefit rolls reaching a three-year high. Initial claims for unemployment insurance rose by 6,000 to 223,000, indicating longer job search times amidst concerns over Trump’s tariff threats against various nations.
The euro slipped to $1.040/€, retreating from a five-week high as investors await clarity on Trump’s policy intentions. His decision not to impose immediate tariffs eased some inflation concerns but left room for speculation about future trade measures.
The British pound fell to $1.230/£, retreating from a two-week high due to growing worries about the UK’s financial outlook and recession fears reflected in consumer confidence data. The UK’s budget deficit for December was larger than expected, further complicating the fiscal landscape under Chancellor of the Exchequer, Rachel Reeves.
Meanwhile, the South African rand traded around R18.50/$ on Thursday afternoon, benefitting from a softer dollar. Despite potential impacts from US protectionist policies, the SARB is widely expected to cut interest rates during its upcoming MPC meeting.
Key indicators:
USD/ZAR: 18.40
EUR/ZAR: 19.24
GBP/ZAR: 22.83
GOLD: $2,776
BRENT CRUDE: $78
Sources: Morningstar, IMF World Economic Outlook Update, KPMG, UK Government, ECB, Trading Economics, Refinitiv and Bloomberg.
Written by Citadel Advisory Partner and Citadel Global Director, Bianca Botes.