What are its implications?
The UK economy unexpectedly shrank in January, posing further difficulties for the government as it grapples with slow growth and inflationary pressures.
According to the Office for National Statistics (ONS), gross domestic product (GDP) fell by 0.1% in January compared with December 2024. This figure disappointed economists, who had predicted a slight increase of 0.1%. The decline follows a 0.4% rise in December, according to a report from The Wall Street Journal.
Manufacturing output dropped by 1.1%, making it the worst-performing sector and raising concerns over the impact of potential trade tariffs. The services sector, which accounts for a significant portion of the UK economy, grew by just 0.1%, while construction output contracted by 0.2%.
A challenging outlook
The weaker-than-expected performance suggests that the UK may struggle to meet its already modest growth forecasts for 2025. The Bank of England (BoE) last month halved its growth projection for the year to 0.75%. The latest figures indicate that the first quarter may be even weaker than anticipated.
Despite economic headwinds, the BoE is widely expected to keep interest rates unchanged at its upcoming meeting, as inflation remains a concern. The annual inflation rate rose to 3% in January and is forecast to increase further in the coming months.
For Chancellor Rachel Reeves, the contraction complicates fiscal planning ahead of the Spring Budget. Weaker growth typically leads to lower tax revenues, making it harder for the government to fund its economic policies without additional borrowing or spending cuts.
Nicholas Hyett, an investment manager at Wealth Club, described the GDP figures as unwelcome news for the Treasury. “The slowdown has been driven by a big slowdown in manufacturing output – unsurprising given the very uncertain outlook for exports with ever changing tariffs,” he said. “We could be at the start of a long, slow slide into recession.”
Housing and consumer confidence
Despite the economic slowdown, consumer finances remain relatively stable, according to Frances Haque, chief economist at Santander UK. “Households are still uncertain about the road ahead and whether to spend now. However, given real wage growth and the continuing confidence households have in their financial position, they are in the right place to kick start spending once greater stability returns,” she said.
Conversely, housing market activity appears subdued. The BoE reported a slight decline in mortgage approvals in January, raising concerns that anticipated increases in housing demand may not materialise before upcoming changes to stamp duty take effect.
Haque remains cautiously optimistic, noting that “we have yet to see whether February’s inflation data, labour market data and the Spring Budget – all landing over the next fortnight – will bring more clarity for households and a boost to confidence.”
Uncertainty over trade and investment
Adding to the economic uncertainty are potential new tariffs from the Trump administration, which could further strain UK manufacturing. The steel industry is particularly vulnerable, with UK exports to the US valued at approximately £370 billion in 2024. Prime Minister Keir Starmer has vowed to “keep all options on the table” in response to these trade threats.
With business investment expected to decline and employment outlooks worsening, the government faces growing pressure to outline a clear strategy for economic recovery in its forthcoming budget statement.
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