Tom Pugh, RSM UK’s economist, explains to Consultancy.UK that the British economy is poised to surge, fuelled by a “sugar rush of government spending” in 2025. But private and public organisations should not lose sight of the risks which caused the economic slowdown of the last few years, which could still push inflation higher, and “disrupt the recovery”.
The UK economy stalled in the third quarter, leading to a resurgence in worries about stagnation. But we expect growth to pick up sharply in 2025. A sugar rush of government spending and investment over the next year will give the economy a significant tailwind. Combined with a revival in consumer spending, as households start to spend rather than save increased income, this should lead to a jump in growth. But that sugar rush of spending, along with some of the other measures announced in the budget, is likely to mean that inflation hovers between 2.5% and 3% next year.
There are two key reasons why we expect the economy to pick up this year. First, the net increase in government spending and investment this year should boost the economy by about 0.5ppts, that represents a substantial tailwind to growth. Second, households’ real incomes have risen by about 3.5% over the past year, but spending has grown by just 1.5% as households are now saving over 10% of their incomes. That’s unusually high and as much as they were saving during the global financial crisis.
As the cost-of-living crisis recedes and consumer confidence builds, we expect households to start saving a lower proportion of their income. What’s more, consumer incomes should continue to grow at a reasonable rate this year. The combination of continued real income growth and lower saving sets the stage for an increase in consumer spending.
However, the risks are growing. Chancellor Reeves left herself with wafer thin headroom of £10bn against her fiscal target after the last budget. The recent move up in gilt yields means she has probably already blown through that buffer. As she has repeatedly emphasised the need for fiscal discipline, she’ll need to get borrowing back below the target by the time the OBR produces its next forecast on 26th March, that means either more taxes or being less generous with some of the spending pledges she announced in the Autumn.
Given she has also said there will only be one fiscal event a year, we assume the Chancellor will pare back spending. That might not mean lower spending this year, but jittery financial markets might not take a pledge to cut spending in the future as particularly credible, meaning reductions are likely to come sooner rather than later.
What’s more, the increase in interest rates over the last month is enough to knock 0.1-0.2ppts off our growth forecast if maintained through the year. Finally, recent economic data has been worse than expected. A lack of economic momentum coming into 2025 raises the chances that growth disappoints at the start of this year.
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