The UK’s inflation rate has been a hot topic again, raising questions as to what the future holds for the UK economy.
New fiscal policies, coupled with global risk factors, are now creating new challenges. After the sharp drop to 1,7% in September of 2024 – below the Bank of England (BoE’s) 2% goal for the first since 2021 – the Bank of England is facing new challenges.
The Office for National Statistics’ (ONS) data shows that the GDP contracted by 0.1% in September, and only grew 0.1% in the third quarter. This is far less than the 0.5% growth seen in the second quarter.
The fragility of Britain’s economic recovery is evident in these figures.
What is causing the inflation rate to increase again?
There are two main forces at work: the domestic fiscal policy and international trade tensions.
Rachel Reeves is the UK finance minister. She has introduced a budget that will spend big to stimulate growth and close funding gaps.
The decision to fund these measures by raising taxes on employers has proven controversial.
Analysts warn of increased costs being passed onto consumers and a rise in prices.
The UK is also facing a challenge of persistent wage rises. Inflationary pressures are still present in the UK economy. Therefore, attempts to boost growth by fiscal or monetary policy could be counterproductive.
Reeves’ policies have already had an inflationary effect on the Bank of England’s (BoE), which has revised their inflation predictions upwards for the following three years.
Tariffs by Donald Trump, the US president-elect, are expected to add inflation globally.
A trade war that involves the UK, other countries and others could slow growth and increase inflation.
The disruption of global supply chains can increase retail prices and production costs, especially for nations that rely heavily on imports like the UK.
Andrew Bailey, Governor of the BoE, has raised concerns about economic fragmentation. However he did not speculate on any specific outcome.
In the future, it is estimated that UK inflation will reach 3% in Q3 2025. This would be higher than BoE’s 2.8% forecast.
Businesses are facing a double squeeze due to the effects of inflation from domestic tax increases. This raises concerns over price hikes and additional strains on households’ budgets.
Why has the GDP growth slowed down?
After the early 2024 rebound, it is difficult for Britain to keep up its momentum.
ONS data shows that the services sector, which is the biggest part of the economy in terms of size, was flat during Q3.
The manufacturing and construction industries contracted in the third quarter, which contributed to the 0.1% weak GDP growth.
The GDP per capita has declined alarmingly by 0.1% over the same time period, and there hasn’t been an annual increase since 2022.
Post-pandemic recover has not been as strong as expected. The GDP has increased by 3% since the COVID outbreak, but this represents a small increase compared with other developed economies.
The only major economy that has performed worse is Germany.
Brexit is continuing to have a heavy impact on the UK. It has exacerbated labor shortages, and has disrupted trade relations.
Businesses are facing higher costs due to the reduced number of available workers. These pressures will be passed through increased wage growth. This is something that concerns the Bank of England for managing inflation.
Growth prospects in the UK are fragile due to a combination of geopolitical uncertainty, such as US Trade Policies, combined with flatlining service, shrinking workforce and geopolitical concerns.
Do fiscal policies help or harm?
Rachel Reeves’ budget is designed to boost growth by increasing public spending and reforming regulatory laws.
The bill includes increased funding for NHS. This is a long-overdue step after years of austerity.
Her decision to increase employer National Insurance Contributions and other taxes is criticized.
The consumer is essentially paying for these measures, which are inflationary.
Reeves is also criticized for her ambitions, including achieving two years in a row the highest GDP per capita growth of all G7 nations. This target is far-fetched, given that GDP only grew by 0.1% during Q3.
Positively, the business investment increased by 1.2% during Q3, making it four quarters in a row of increases.
Analysts like Sanjayraja of Deutsche Bank, however, warn that increased taxes on business could reduce investment and employment in 2025.
What is next for UK’s economy?
It is unclear which way to go. Reeves pledged “growth through reform and investment,” but weak business and consumer confidence could hinder the progress.
The UK economy has grown only twice in the last six months. This suggests deeper structural problems.
BoE also considers putting brakes on its monetary policies.
The rate was cut to 4.75% in early February, but the government indicated that it may not be able to lower rates further.
These risks have led to a reduction in investor expectations of rate cuts until 2025.
Analysts expect modest GDP growth despite the efforts of both government and BoE.
In the short-term, forecasts indicate that inflationary pressures and government spending will help support growth.
These gains could be limited by geopolitical risk, trade wars, and missteps in domestic policy.
New fiscal policies, as well as global trade risk, threaten to reverse the progress made in lowering inflation.
What is driving UK inflation? The ICD first published the post What’s driving UK inflation concerns?
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