With contributions from Kristina Hooper, Chief Market Strategist, Man Group.
Thursday’s UK GDP report for April showed a larger-than-expected drop of 0.3% month-on-month – the steepest decline since October 2023. The disappointing data – undoubtedly affected by property tax changes – prompted some market observers to express concerns about the UK's economic outlook. But looking ahead, is it really doom and gloom?
The Citigroup Economic Surprise Index for the UK certainly doesn’t suggest so. It is on an upswing (unlike some other major economies, such as the US), reflecting that other recent economic data has beaten expectations. For example, April retail sales were up 1.2% month-on-month, far exceeding expectations.1
Figure 1: Citigroup Economic Surprise Index on an upswing for the UK
Source: Yardeni Research, as of 13 June 2025. Available here: https://yardeni.com/charts/citigroup-economic-surprise/
Policy support set to drive growth
More important is the government's proposed fiscal stimulus on the way. Chancellor of the Exchequer Rachel Reeves released the government’s three-year spending review on Wednesday, outlining how it plans to allocate spending. For current spending, the government will focus on healthcare and, to a lesser degree, defence and energy. Capital spending will focus on areas such as housing, transport infrastructure, energy and R&D. Most of these areas of spending will likely have high multiplier effects, which should have a more positive impact on the UK economy.
The UK should also benefit from having already cemented a tariff agreement with the US that has relatively favourable terms. That puts a lot of economic policy uncertainty to bed, which has historically been an obstacle to business investment. All in all, I expect the UK to be able to exceed expectations of 1% GDP growth for the year.
The stagflation threat
The biggest risk is that the UK falls into a stagflationary environment. We saw a bigger-than-expected increase in overall inflation; and services inflation in the UK rose back above 5% in April.2 There is the potential for sustained elevated inflation, partially driven by higher labour costs. Growth could then weaken if prices rise materially and soften demand, resulting in stagflation. However, I don’t think this is a likely scenario. Inflation might be elevated but I expect that to be temporary, as the Bank of England anticipates, and I believe growth will be higher-than-expected as well. That is not a stagflationary environment.
Indeed, inflation could soon ease for several different reasons. The labour market is showing signs of loosening, which should ease wage growth. In addition to the US-UK trade deal, which should help to ease inflation, the UK and European Union have reached a “reset deal” that could lower costs in a number of ways. For example, the deal includes a provision allowing for greater mobility between the two economies for young workers (of course we are still waiting on details of the plan, which will determine just how impactful it will be).
The bottom line: cautious optimism
Despite last week’s GDP numbers, my outlook for the UK for the remainder of the year is relatively positive. In the shorter term, government spending should provide meaningful support for the economy. Expectations for economic growth are low, and I believe the UK will exceed those expectations – although we must stay alert to the risk of sustained higher inflation. While it’s a foregone conclusion that the Bank of England will not alter interest rates at its meeting later this week, I will be paying close attention to its expectations for growth, and especially inflation.
1. Source: UK Office of National Statistics, 22 May 2025.
2. Source: UK Office of National Statistics, 21 May 2025.
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