UK quarterly economic outlook – Q2 2025

Headline inflation jumped to 3.5% in April, where we forecast it will stay for the rest of the year. Most of the increase is due to one-off events, such as tax rises and regulated price increases. Inflation should come back down towards 2.5% in early 2026. However, persistent pressures – including employees looking to protect their real incomes with punchy wage-rise negotiations and businesses their margins – mean inflation is unlikely to return to the 2% target until 2027.

The Autumn Budget’s payroll tax hikes that came into effect in April have cooled demand for labour. While there is no surge in unemployment, we can see from looking at various datasets that vacancies are now below pre-pandemic levels. Firms are responding to higher employment costs with hiring freezes. We expect these trends to track throughout 2025, taking some of the heat out of exceptionally strong pay growth.

The Monetary Policy Committee (MPC) finds itself at a crossroads this quarter. Both inflation and wage growth are too high to justify a faster pace of cuts but growth is fragile. Despite April’s inflation jump, we still expect the MPC to keep to its careful and gradual path of lowering interest rates this year. We anticipate two more 25bps reductions in the second half of 2025 to bring interest rates in at 3.75%. But the risks are weighted towards just one additional cut.

The gangbusters growth of Q1 is likely 2025’s economic high point. Now in Q2, we are facing a storm of tariffs, systemic uncertainty, higher taxes, a softening labour market and a global economic slowdown. Yet, consumer spending has finally started to pick up. Lower interest rates and stronger government spending should also help to shelter the economy from at least some of the global headwinds. Ultimately, this year is likely to feel similar to last with growth of a little over 1%. But both the upside and downside risks are more significant.

The economic impact of US trade tariffs resonates globally. In the US, after some roll-back on the so-called reciprocal tariffs, Q2 could see growth recover slightly from its initial hit. To what extent depends on factors including how inflationary tariffs turn out to be and we still haven’t totally ruled out a US recession. The Federal Reserve has also indicated it’s in no rush to cut interest rates. Across Ireland and the rest of the eurozone, tariffs hamper growth prospects here too. Yet, planned increases to defence budgets could add 0.5ppts to the region’s GDP next year. Overall, the global economy is heading towards a period of relatively higher inflation and interest rates and subdued growth compared to pre-pandemic.