- GDP growth of 0.7% in Q1 was a welcome ‘good news boost’ during an otherwise uncertain period. Higher US tariffs and ongoing US policy uncertainty will undoubtedly reduce global economic growth this year. However, the impact on the UK will be cushioned by the tariff being set at the ‘baseline’ 10% rate, together with some positive impacts from the government’s recent limited trade deal, and the relatively low proportion of UK exports accounted for by US-destined goods. The 90-day pause on global ‘reciprocal’ US tariffs above the 10% baseline is set to expire on 8 July.
- The strong UK economic growth experienced in Q1 is not likely to persist. The latest Treasury-compiled consensus forecast (May) is for below-trend economic growth of 1.0% in 2025, in line with the Office for Budget Responsibility’s forecast produced for the Spring Statement and the Bank of England’s view. Growth this year should therefore be similar to that achieved in 2024 (1.1%), and is expected to continue at broadly the same rate in 2026 (the Treasury-compiled consensus suggests 1.1%).
- Inflation has risen to its highest rate since January last year, with annual CPI jumping to 3.5% in April, reflecting the impact of increasing household bills. However, inflation looks set to peak relatively soon as recent reductions in wholesale energy prices should feed through to utility bills from July. Indeed, the Bank of England expects CPI to start falling from Q4 (forecast at 3.3%), and to continue moving back towards its target rate in 2026, reaching 2.1% by Q4 next year.
- That said, the inflation outlook is particularly uncertain. Upward pressure is coming from April’s rise in the National Living Wage and Employers' National Insurance Contributions (the impact of which is difficult to predict) as well as above-inflation wage growth. Conversely, recent gains in the value of Sterling against the US Dollar should have a downward effect. The impact of US tariffs is also difficult to judge, as it could help to ease inflation (if, for example, exports from Asia that were previously destined for the US are ‘dumped’ in European markets), or to raise inflation (if supply chains are disrupted, or global manufacturers spread the cost of US tariffs across all markets).
- The Official Bank Rate was cut by 25 basis points to 4.25% in May, its lowest level since April 2023. We expect further reductions this year, given the expected fall in inflation next year (looking beyond the current short-term acceleration) and the subdued outlook for growth. The May Consensus forecast suggests that either one or two further 25-basis point cuts is likely.
Recent output trends and indicators
- The first estimate of Q1 GDP growth showed the UK economy expanding by a strong 0.7%, up from 0.1% in the previous quarter. This represents the strongest rate of growth since Q1 2024. The services sector grew at 0.7%, and the production sector saw a 1.1% increase following three consecutive quarterly declines, but construction output saw no change. On a monthly basis GDP increased by 0.2% in March following 0.5% the month before.
- The S&P Global UK Services PMI moved into contraction territory in April, falling from a strong 52.5 in March to 48.9. This also ended a run of 17-months of expansion for the sector. New orders and employment both fell, with subdued domestic demand being blamed on the negative impact of US tariffs. Inflation rose quickly across both input and output costs while business expectations on future activity weakened.
- The UK Manufacturing PMI for April rose a little over March to 45.4 (from 44.9), but clearly remains very much in contraction territory. Output declined as manufacturers decreased production in a variety of areas due to weakening demand both domestically and internationally. Rising economic and trade uncertainty is almost entirely to blame for this fall. Employment fell at the second-steepest rate in almost five years, input costs rose at their fastest pace since December 2022, and business confidence deteriorated to a 29-month low.
- The S&P Global UK Construction PMI rose slightly in April to 46.6, up from 46.4, although still the fourth consecutive month of contraction. This month saw further new order declines as business uncertainty delayed projects. All three sub-sectors were below ‘50’ with commercial work falling sharply to 45.5, while residential work showed its mildest decline this year, with a reading of 47.1. Purchasing activity fell at the fastest rate in five years amid rising material and pay costs.
Labour market
- April’s unemployment rate moved up to 4.5% from 4.4% in March, according to the latest Official Labour Force Survey. The total employment rate fell to 75.0% from 75.1% in the previous reading.
- Early estimates suggest the total number of payrolled employees fell by 33,000 during April and by 106,000 over the year. Job vacancies fell by 43,000 in the three months to April, the 34th consecutive quarterly fall, to put total vacancies at 761,000. Vacancies are now 34,000 below their pre-pandemic January - March 2020 level and have seen a 41% fall from 1.3 million vacancies recorded during the same period three years ago.
- Annual growth in employees’ average regular earnings (excluding bonuses) was 5.6% in the three months to March, down slightly from 5.9% last month. Once again, it was the wholesaling, retailing, hotels and restaurants sector which saw the strongest growth rate, followed by the construction sector.
Inflation
- CPI inflation jumped to 3.5% in the 12 months to April, up from 2.6% in March, and higher than consensus expectations of 3.3%. Price increases from household bills including utilities (following Ofgem’s new energy price cap from April) placed the strongest upward pressure on inflation, although a strong upward contribution also came from rising transportation costs. Discounting across clothing and footwear helped contribute to some downward pressure during the month.
- Core CPI (excluding volatile elements such as energy and food) rose at 3.8% in the 12 months to April, up from 3.4% in March. The annual services CPI rate rose from 4.7% to 5.4%.
- All-items CPI looks set to remain above 3% for the rest of this year. The Bank of England expects CPI of 3.5% in Q3 (the same as the current rate), falling slightly to 3.3% in Q4, and falling further towards the target rate in 2026, reaching 2.1% by Q4 next year. The latest consensus forecast (May) expects CPI of 3.0% in Q4 2025 and 2.3% in Q4 2026.
Interest rates
- The Bank of England’s Monetary Policy Committee (MPC) reduced the base rate by 25 basis points to 4.25% at its May meeting, marking the fourth reduction from a peak of 5.25%, and the second cut of 2025. A majority of 5–4 voted for a 25-basis point cut, with two members preferring to reduce Bank Rate by 0.5 basis points (to 4.0%) and two preferring to maintain Bank Rate at 4.5%.
- Further cuts to the base rate are likely this year, despite this month’s sharp rise in inflation. The MPC notes an expected slowing of wage inflation as the labour market cools, a broader easing of supply-side pressures, a weaker outlook for global (and to a lesser extent UK) GDP growth, and also that it views the overall impact of global US tariffs on the UK as more likely to be disinflationary than inflationary (but with significant uncertainty). In addition, wholesale energy prices have fallen recently, and this should start to feed through to lower bills when Ofgem’s energy price cap is reviewed in July. The next MPC decision is scheduled to be published on 19 June.