Economic outlook

The UK economy is gradually turning a corner. Following a technical recession in the second half of 2023, GDP rebounded by 0.6% in the first quarter of 2024. Business surveys, including a composite of PMI and the Lloyds Business Barometer, are consistent with a re-acceleration of growth.

The external environment is also expected to recover following the weakness last year, although there are still risks associated with geopolitical tensions and supply chains.

There are a number of reasons for optimism. Consumption has been supported by the cuts to National Insurance Contributions, which are expected to boost real household disposable income by 1%. Consumer confidence is gradually recovering, consistent with continued tightness in the labour market and the fall in inflation. Mortgage rates are normalising, and the drag from higher borrowing costs should soon begin to ease. Household utility bills fell by 12% in April and are set to fall by a further 7% in July.

Business investment could also return as an engine of growth. Political uncertainty will now resolve sooner than expected. A summer election is likely to be followed by a fiscal event in the autumn, where the new government will set out its economic agenda.

Corporate insolvencies are down on a year ago and there are some tentative signs of a pickup in M&A activity. While some businesses are still waiting for a cut in interest rates as a signal of a more sustained easing in financial conditions, the appetite to invest is there, as evidenced by solid growth in capital expenditure in Q1.

Inflation has returned to its 2% target. But measures of domestic inflationary pressure – including services prices – have been stickier. Labour costs make up a large part of services firms’ production costs, and pay growth has been slower to adjust.

Continued progress on inflation will favour a gradual withdrawal of monetary policy restrictiveness in the coming months, although market expectations for interest rate cuts have been scaled back since the start of the year. We expect Bank Rate to fall towards 3% by the second half of 2025.

The demand for labour is down across the board, although some sectors – including hospitality and transport – are still experiencing wage pressures. This is partly explained by the near 10% rise in the National Living Wage in April.

The slowing in demand should, nevertheless, support a moderation in pay growth going forward, as employers expect to pay lower bonuses this year and don’t anticipate one-off payments as was the case during the cost-of-living crisis. A cooling labour market could also lead to a gradual increase in the unemployment rate, although we expect any pickup to be relatively modest by historical standards.

The fiscal reality is similar for whichever party wins the general election. Interest rates are set to remain higher, debt more difficult to bring down, and spending pressures on health and defence continue to mount. With only nuanced differences in the stated plans for fiscal rules and taxation, borrowing will likely follow a similar path under either government.

The first challenge for the new government will come in the form of a spending review, which will set departmental budgets for 2025-26 onwards against a backdrop of limited fiscal space.