Can we still shift the dial on growth?

Keir Starmer’s government must have hoped for an entirely different first six months in office, one where it spent less time on the back foot, and where the storm over its October Budget and plan to appropriate an extra £40bn annually from businesses had entirely abated by now. But months before this extra revenue raising has even begun, firms remain in unforgiving and fragile mood, with the Budget mauling sitting at the heart of the gloomy prognosis for economic growth in 2025. Indeed, the chill wind blowing in from the 30-year gilt market this week, where yields are exceeding levels reached during the Liz Truss 2022 spike, has reinforced fears that further tax raids – what Deutsche Bank has called the Budget’s “painful sequel” – could lie ahead. 

Labour sailed to victory last July on a promise that it would make the UK the fastest growing economy in the G7, a vision that stands in stark contrast to the low expectations for economic growth at the start of 2025. The consensus forecast is for expansion of 1.3 per cent this year – not a recession but hardly rip-roaring. If Labour expected eagerness and confident anticipation from the private sector at this stage, the reality is rather more despondent. 

Private sector firms are expecting reduced activity in this first quarter, according to the CBI’s latest survey. The organisation has warned that both output and hiring numbers are likely to fall, while manufacturing output fell at the fastest pace since 2020 in the quarter to December. There's another steep drop to come thanks to a perfect storm of weakening external demand, uncertainty over US trade policy and a “collapse in domestic business confidence in the wake of the Budget”. 

Anna Leach at the Institute of Directors says its members remain cautious on prospects, with profit uncertainty the number one constraint cited. Almost a quarter of IoD business leaders are planning to make no investments this year. 

The British Chamber of Commerce’s most recent survey revealed that 63 per cent of firms say tax is now a worry with only a fifth of businesses saying they have increased investment plans. 

Businesses see the NIC changes as particularly damaging – the Centre for Policy Studies points out that in 2024 employers paid £1,617 for each full time employee on a minimum wage and that in 2025 they will pay £2,583 for the same employee.

Hobbling businesses through brutal NIC hikes is a terrible mistake and one that could have been avoided if alternative tax measures had not been ruled out by gimmicky pledges. Headcounts may be cut, fewer jobs created and investment plans may be paused as businesses try to minimise the hit to their profits.

Meanwhile rising bond yields, which may force chancellor Rachel Reeves to make the economically damaging decision of further increasing taxes or cutting back on spending, also risk crowding out private sector economic activity, says Kallum Pickering at Peel Hunt.

Factors that could help move the dial on growth this year include monetary easing. Many economists are convinced that in such an arid landscape the Bank of England will have little choice but to increase the pace of rate cuts. Capital Economics is another to think the growing likelihood of the chancellor missing her main fiscal rule suggests either spending restraint or further tax rises, both of which would act as a headwind to economic growth and support the case for more rather than fewer cuts. After years of high interest rates, a faster downwards pace should inject some momentum into the economy. It would certainly ease some of the financial pressures on businesses, and open the door to “lower levels of consumer caution”, says Matt Swannell at EY Item Club. Capital notes that consumer spending grew 0.5 per cent in Q3 and says that as rates fall, so too will households’ saving rate.

Indeed, an expectation of rising household consumption as rates fall and households start to spend some of the large savings buffers they’ve built up means KPMG sees GDP growth rising to 1.7 per cent this year.

Much higher government spending running to tens of billions, a shake-up of planning rules to kickstart infrastructure and housebuilding projects, and the new industrial strategy to be revealed in the spring could in addition act as badly needed stimuli that help nudge the dial in low-growth Britain.