Improving real wages will support a slow economic recovery

Inflation has declined to around the 2% target but is projected to stay slightly above this level throughout the remainder of 2024 and into 2025. The persistent trend is driven by stubbornly high inflation in the service sector and the re-emergence of price pressures on goods due to labour costs as well as recent supply chain pressures. The labour market has normalised somewhat with unemployment and vacancy rates back to pre-pandemic levels. However, given that labour supply is still tight, and the economy is recovering, unemployment is expected to remain around its current rate (4.2-4.6%). The limited labour supply and current unionised salary agreements are expected to continue to drive higher nominal wage growth in 2025.

The Bank of England (BoE) initiated its first rate cut in August 2024, thus marking the beginning of a gradual easing cycle. However, the pace of rate cuts is expected to be slow, meaning that interest rates will remain elevated throughout 2025. Household confidence is continuing to improve as inflation eases and nominal wages are picking up. Along with only marginally higher unemployment, household consumption is expected to improve and support domestic growth, which will be further supported by rising house prices that will increase people’s net worth.

Overall exports are seeing a rebound after bottoming out in early 2024, partly on back of a recovery of merchandise trade but particularly due to service exports which have been growing steadily. Nevertheless, the introduction of border checks introduced in 2024 is expected to continue to cause some friction and higher costs of trade between the EU and the UK. The current business environment is characterised by a cautiously optimistic outlook as the credit landscape, though tight, shows signs of improvement partly due to gradually falling interest rates. However, the rise in banks’ non-performing loans presents a challenge and is tempering some of this optimism. We anticipate a modest increase in insolvencies in 2024 – after already +12% in 2023 – driven by the financial strain on businesses, particularly those struggling with debt. However, the situation is expected to stabilise by 2025 as the economy adjusts. Despite these improvements, rollover risk remains high for companies with fixed-rate debt posing an ongoing threat to their financial sustainability, and insolvencies remaining much higher than before the pandemic.

Gradual improvements in fiscal situation but more borrowing is expected

The new government's economic policies aim to stimulate growth by prioritising investments in infrastructure, energy, transport, and housing. However, the effectiveness of many of these policies is dependent on the passing of a potentially controversial Planning and Infrastructure Bill, which is expected to face significant local opposition due to concerns over environmental and community impacts. The bill is expected to be implemented by mid-2025 if it does not face too much resistance. Additionally, the government's limited fiscal headroom has restricted the scope of its initiatives, with many of its initial policies either being legislative in nature or trying to attract private investments. However, given the government’s intentions and its self-imposed limit on significant tax rises, it is expected that public finances will improve more slowly than indicated in the previous budget.

In 2024 and 2025, the UK's fiscal situation is expected to undergo a marginal narrowing of the fiscal deficit, primarily driven by strong tax revenue collection. The improvement will be fuelled by rising wage growth, low unemployment, and higher consumption levels, which bolster tax income. Although the new government plans to implement some tax increases, the primary contribution to the deficit reduction will come from these robust economic factors rather than from significant policy shifts. Although government spending is also expected to rise under the new administration, the debt burden is anticipated to gradually decline over time, reflecting the slight fiscal improvements and cautious management. The BoE is expected to continue offloading its government bond holdings in 2025. At September 2024, these holdings amount to GBP 658 billion, following reductions of GBP 80 billion between October 2022 and September 2023, and a further GBP 100 billion from October 2023 to September 2024. The BoE is expected to focus primarily on cutting back on its holdings by allowing bonds to mature rather than actively selling them, with approximately GBP 80 billion in bonds set to mature over this period.

In 2025, the UK's current account is expected to show signs of improvement, with the persistent deficit in the balance of goods being partially offset by a surplus in the balance of services. Service exports are anticipated to continue their positive trajectory, bolstered by the UK's strong global position in sectors such as finance and professional services. Additionally, while imports will be driven by accelerating private consumption, goods exports are forecast to rebound faster in 2025 after hitting a low in early 2024, thereby contributing to a more balanced trade outlook. Although the border check arrangement introduced in 2024 is expected to continue to cause friction and higher costs of trade between the EU and the UK, the impact is expected to be relatively minor, allowing for gradual progress in export performance.

The new government will be limited by fiscal situation but expected to be proactive and ambitious

The Labour Party and its Prime Minister Sir Kier Starmer won a comfortable majority in the July 2024 elections, gaining 411 seats (up 214 seats from the previous general election) and well clear of the 326 needed for a majority. The incoming government is expected to be relatively centrist and fiscally conservative but more proactive around building and industrial policy. However, unless it increases taxes or government borrowing, the administration will be limited by fiscal restrictions.

While strike action eased in 2024, the first half of the year still saw 465,000 working days lost due to industrial action. The situation should ease in late 2024 and 2025 as Labour have been quick to mention the possibility that public wages should increase to tie in closer to recommendations by independent pay review bodies (around 5.5%) and has agreed new pay offer deals with both the train union (Aslef) and junior doctors (BMA).

The Labour government is expected to take a closer stance with the European Union (EU) than the previous government, even if Kier Starmer has made it clear “about not rejoining the EU, the single market or the customs union or a return to freedom of movement”. The recent draft Product Safety and Metrology Bill is an example as it will make it easier to align UK and EU legislations.