UK Quarterly Economic Outlook – Q3 2025

In Q2, we predicted the UK’s GDP growth trajectory for this year would be erratic. The data so far hasn’t disappointed. Buoyed by higher government spending, consumers, service providers and manufacturers in the real economy ultimately held their nerve against tariff headwinds and low confidence. Despite April and May's contractions, we head into Q3 and the second half of the year with 1.1% GDP growth already in the bank.

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Our UK inflation outlook for 2025 and into 2026 sees inflation peaking at 4% in September before dropping back to just under 3% next April. Inflation is set to remain well above the 2% target, averaging 3.5% in 2025 and 2.9% in 2026. Another round of tax rises this autumn and higher food and fuel prices are heightening inflation expectations as we head into the second half of the year. This gives Monetary Policy Committee (MPC) members much to think about at the next interest rate decision meeting.

Mindful of the well-publicised challenges with the UK’s official labour force statistics, our analysis suggests we can expect just a slow increase in the unemployment rate in the second half of this year. We also anticipate pay growth will end 2025 at around 4% as firms try to recoup April’s rise in employment costs while the labour market slows. Nevertheless, pay growth is still higher than the MPC is comfortable with, although inflation will drive real income growth close to zero by the end of the year.

The MPC faces a finely balanced decision as to when, and possibly even if, the Bank of England (BoE) will next cut its base rate. Above-target inflation faces further pressure from food and fuel prices in Q3, which households and businesses will feel keenly. However, we expect interest rates to settle at around 3.5% next year after the next cut in November or February, depending on jobs and inflation data.

Bound by fiscal rules and Labour Party manifesto commitments, Chancellor Rachel Reeves looks almost certain to have to make the next Autumn Budget a tax-raising event given the UK’s unsustainable public finances. Boosting her fiscal headroom to £25bn would keep the markets’ confidence. But how and at what cost to inflation, business and consumer confidence? Among the options are freezing income tax thresholds, increasing “sin” taxes and duties, and possibly pensions and property tax reform.

The  UK economy is in better shape than it perhaps feels to us as businesses and consumers. Despite economic growth slowing over the second half of the year compared to the first, we still expect the economy to grow by 1.3% this year and next. Headwinds include a slight decline in the consumer spending forecast, unemployment likely rising to around 5%, with slower wage growth and above-target inflation adding to this picture.

UK economic growth outpaced that of our G7 competitors in the first half of 2025. We see the UK (1.3%) continuing to outperform the US (1.1%) and eurozone’s (1.1%) economic growth in 2025. However, the UK will fall short of the IMF’s forecast for a 3% increase in global output. As the world economy moves into a period of relatively higher interest rates and inflation, putting pressure on public debt, US economic policy remains the big uncertainty, despite President Trump’s post-April “trade deals”.