The UK economy contracted unexpectedly at the start of the year, illustrating the challenging backdrop for Rachel Reeves’s spring statement on March 26.
Gross domestic product (GDP) decreased by 0.1 per cent in the month to January, down from growth of 0.4 per cent in December, the Office for National Statistics (ONS) said on Friday. Analysts had expected the economy to expand by 0.1 per cent.
A steep 0.9 per cent drop in output in the production sector dragged overall growth lower. Services output increased by 0.1 per cent over the month after rising by 0.4 per cent in December, while construction activity fell by 0.2 per cent. Over the three months to January, GDP increased by 0.2 per cent compared with the three months to October.
Liz McKeown, director of economic statistics at the ONS, said: “The fall in January was driven by a notable slowdown in manufacturing, with oil and gas extraction and construction also having weak months. However, services continued to grow in January led by a strong month for retail, especially food stores, as people ate and drank at home more.”
Since the budget in October, economic growth has undershot expectations, which will probably force the chancellor to make cuts to government spending in the spring statement so that she can stay within her fiscal rules. She is considering trimming welfare expenditure as the government is under pressure to increase defence spending after President Trump signalled that he intends to roll back military support for Europe.
Reeves said: “The world has changed and across the globe we are feeling the consequences. That’s why we are going further and faster to protect our country, reform our public services and kickstart economic growth to deliver on our plan for change.”
Yael Selfin, chief economist at KPMG UK, said: “The upcoming spring statement is unlikely to deliver additional fiscal stimulus for the UK economy. The sluggish growth outlook, alongside competing spending pressures will force the chancellor to tighten purse strings.”
The Office for Budget Responsibility (OBR), the official forecaster, is set to slash its growth projections and warn Reeves that the public finances are exceedingly stretched. A sharp rise in UK government borrowing costs, alongside poor growth, has partly eroded the £9.9 billion of fiscal headroom Reeves left at the October budget.
The latest GDP figures do not take into account Trump’s announcements of tariffs on some of the US’s key trading partners in February and March. Economists have warned that his volatile policymaking will disrupt global trade and constrain growth. Stock markets have fallen sharply this month.
Hailey Low, an associate economist at the National Institute of Economic and Social Research think tank, urged the chancellor not to follow in Trump’s footsteps and resist “frequent policy U-turns [that] risk undermining business and investor confidence at a time when clarity and consistency are most needed”.
The Bank of England is expected to keep interest rates unchanged next week at 4.5 per cent after inflation climbed to 3 per cent in January. Growth had exceeded the central bank’s expectations at the end of last year.
On Thursday the ONS delayed the release of its monthly trade statistics, which are usually released alongside its GDP estimate, owing to data collection errors. The statistics agency has also been criticised for allowing responses to a survey that generates its monthly labour market data to collapse.
The FTSE 100 climbed by 1.05 per cent, or 89.77 points, to close at 8,632.33. The pound weakened by 0.19 per cent against the dollar to $1.29 and dropped by 0.46 per cent against the euro to €1.18.
Analysis: Difficult choices ahead
It is not a foregone conclusion that the OBR will demand that Rachel Reeves makes swingeing public spending cuts or further tax rises to ensure she continues to comply with her main fiscal rule: financing day-to-day government spending with taxes by 2029-30 (Jack Barnett writes).
Growth has undershot OBR forecasts since the October budget. January’s shock 0.1 per cent fall in GDP underlined the tough economic conditions the chancellor is grappling with. Over the next few years GDP is set to be lower than expected, undeniably bad for the public finances.
However, wage growth has been exceptionally high: private sector wages increased by 6.2 per cent in the three months to December. Wages are very tax-rich, meaning that, when they rise sharply, they boost Treasury coffers. This effect is greater when income tax thresholds are frozen, as they are now.
The chancellor is thought to be aiming to trim welfare spending in her spring statement. Her fiscal headroom could receive a double lift from this action. Alongside the mechanical uplift to the headroom from the spending reduction, the OBR may judge that less generous benefits steer people toward the labour market, so increasing tax revenues.
The spending watchdog also used financial market data in the ten working days to February 12 to underpin its preliminary forecasts, bypassing the rapid ascent in government bond yields at the beginning of the year.
Even before that recent rise in yields, the OBR had warned in October that debt interest spending would top £100 billion in each of the next five years, so it is without question that at least a fraction of the £9.9 billion fiscal cushion has vanished.
However, the spending watchdog will consider factors beyond sluggish growth and higher debt interest spending, possibly giving Reeves a reprieve.
