UK quarterly economic outlook – Q4 2024

Headline inflation is expected to rebound from just over 2% in October to around 3% early next year. However, unless energy prices rise significantly, inflation is unlikely to exceed 3%, avoiding a return to recent ‘stagflation’. By the second half of 2025 and into 2026, inflation should trend back down towards 2%.

Three factors are driving this rebound: rising energy prices, budget measures increasing costs, and faster economic growth. Despite these pressures, inflation is not expected to spiral out of control. Meanwhile, services inflation, a key domestic indicator, is projected to stabilise, allowing for potential interest rate cuts from the BoE. Geopolitical risks, such as conflicts affecting energy supplies and global trade tensions, pose the main threats to this outlook. But the overall forecast remains cautiously optimistic, with inflation stabilising in the medium term.

The labour market remains tight but is gradually loosening as workforce growth picks up and hiring stays subdued. Wage growth appears choppy, with significant public sector pay increases and a rise in the National Minimum Wage (NMW) masking a slowdown in private sector pay growth.

Despite recent volatility in the unemployment rate, which has fluctuated between 4% and 4.4% this year, broader employment measures suggest the labour market is gradually easing. Vacancies are falling, and the number of people on payrolls has decreased for the past two months, easing recruitment difficulties for firms. The unemployment rate is expected to rise gradually to 4.5% by the end of 2025, aligning with the BoE's neutral rate.

Wage growth will be uneven, rebounding above 5% in Q4 due to public sector pay deals and the NMW increase in April 2025. However, it is expected to slow to around 3% by the end of next year as the labour market loosens and firms adjust to budget-induced cost increases.

Despite a rebound in headline inflation, the BoE is set to reduce interest rates next year, likely cutting once a quarter. By the end of 2025, rates are expected to be around 3.75%.

The BoE's decision to reduce interest rates will be driven by three main factors: the temporary nature of inflation drivers like the minimum wage increase, a slowdown in wage growth reducing inflationary pressures, and current interest rates being overly restrictive. The Monetary Policy Committee (MPC) is planning a gradual approach, stepping back from rhetoric around aggressive cuts.

While four rate cuts are anticipated in 2025, risks lean towards fewer cuts due to uncertainties from the budget and potential inflationary impacts from the new Trump administration in the US. Longer term, we expect rates to stabilise between 3% and 3.5%.

Growth is expected to accelerate in 2025, driven by rising government and consumer spending as real incomes increase, interest rates decline, and budget measures take effect. The economy likely grew by about 1% in 2024, despite the slowdown in Q3. Yet, key sectors performed well, with consumer spending up 0.5% quarter-on-quarter (q/q), government spending up 0.6% q/q, and business investment up 1.1% q/q.

Real household disposable incomes surged by 3.3% over the past year, driven by robust wage growth, previous tax cuts, and falling interest rates. This trend is expected to continue in 2025, albeit at a slower pace. The declining drag from interest costs and renewed consumer confidence post-budget should translate into increased spending.

However, several risks remain. Geopolitical events, particularly in Russia or the Middle East, could drastically push up energy prices, leading to higher inflation and a potential return to stagflation or recession. Uncertainties around US economic policies also pose a threat. Potential tariffs on UK exports to the US could reduce economic output, and higher inflation and a stronger dollar in the US could increase UK inflation.

Overall, we expect growth to reach 1.8% in 2025 before tapering to around 1.5% in 2026 as the sugar rush of budget stimulus wears off.

Since the pandemic, the US has been the standout performer, a trend expected to continue into 2025. However, the UK is projected to grow faster than the eurozone, narrowing the gap that has widened since 2019. The US economy has grown by nearly 15% since 2019, driven by fiscal spending, strong consumer demand and labour force growth, compared to around 5% growth in the UK and eurozone. While the US will likely continue to outperform, the margin will shrink as UK and eurozone growth accelerates.

On the inflation front, the outlook varies. The UK is expected to see an uptick in inflation due to recent budget measures, whereas inflation in the US and eurozone should decline. As a result, interest rates might stay higher in the UK compared to the US and eurozone, although overall rates are expected to fall across all regions.