AT THE ECONOMIC CROSSROADS

Samantha Amerasinghe reviews the UK economy as its new government takes over

The UK’s broader economic backdrop was fragile even before the general elections on 4 July – which Sir Keir Starmer’s Labour Party won in a landslide over the Conservative Party – despite revised official data indicating that it had pulled out of recession at a quicker pace than previously thought.

It’s necessary to understand the state of the UK economy compared to its G7 peers and the global landscape, assess its strengths and weaknesses, and take stock of what the new prime minister is likely to inherit.

Data from the Office for National Statistics indicates that the United Kingdom’s GDP expanded in the first quarter of this year by 0.7 percent from the previous three months due to higher household spending and a larger contribution from net trade.

This expansion follows two successive quarters in the second half of 2023 when GDP fell due to high interest rates and the lingering effects of last year’s surge in inflation dragging on growth.

The 0.7 percent sprint was the fastest quarterly growth since the end of 2021 and ended last year’s technical recession. It was also surprisingly the highest growth of any G7 country.

However, this didn’t deter the OECD from predicting that the UK will be the worst performing economy in the G7 in 2025 with a growth rate of one percent – behind Germany at 1.1 percent. The US and Canada are expected to be the fastest growing economies in the G7 next year with both growing 1.8 percent.

The United Kingdom’s economy has been struggling since the previous election. The pandemic dealt a lasting blow to the labour force while a surge in inflation following Russia’s invasion of Ukraine and post-Brexit trade friction also wreaked havoc on the economy.

Meanwhile, the Organisation for Economic Cooperation and Development also downgraded its forecast for the UK’s growth this year to 0.4 percent. Growth will be dampened by persistent price rises in the services sector and shortages of skilled staff.

This will push back expected cuts in interest rates by the Bank of England until September at least. The OECD predicts that the bank will reduce the cost of borrowing from 5.25 percent to 3.75 percent by the end of 2025.

Nevertheless, all is not bad because the OECD has forecast a more optimistic outlook for the global economy, which it says is gaining strength despite the threat of worsening conflicts in Ukraine and the Middle East.

Though the global outlook remains modest, there are signs that it is beginning to brighten. Global GDP is projected to be 3.1 percent this year (unchanged from 2023) before edging up to 3.2 percent in 2025, helped by stronger growth in household incomes and lower interest rates.

As for the global outlook, it’s a mixed bag with a recovery expected in the Eurozone while growth will be moderate in the US, India and other emerging market economies. Consumer price inflation in G20 countries is expected to gradually ease to 3.6 percent in 2025 from 5.9 percent this year and projected to be back on target in most major economies.

The UK’s new prime minister will inherit an economy that’s on a steadier recovery path compared to its weak performance over the past few years, as indicated by the upward revision of first quarter GDP.

And the Bank of England says that it expects the solid growth seen at the beginning of this year to continue in the second quarter, for which it forecasts an expansion of 0.5 percent – up from the 0.2 percent expected in May.

Even though the economy is on a stronger footing however, the new government will need to maintain a high degree of fiscal prudence since inflation is still above target; it also needs to have a strong focus on productivity by increasing public investment.

In a nutshell, the UK (ranked as the ninth largest economy in the world) benefits from strong exports of services and a solid education system. But low investment and productivity growth are among its weaknesses.

Although first quarter growth was revised upwards, the economy is underperforming compared to trends before the financial crisis and pandemic. The UK hasn’t grown faster than two percent a year on a regular basis since before the 2007/08 global financial crisis.

Moreover, productivity growth has increased by only six percent since mid-2008 while it has soared by 24 percent over the same period in the US.

Britain underperforms in the export of goods but outperforms other economies in services, which account for 80 percent of the domestic economy. Furthermore, growth in services has been supported by investments in AI with the UK ranking third in the world after the US and China for venture capital invested in artificial intelligence and data startups.

Though the new government has been handed an improved economic backdrop, boosting and sustaining growth will be critically important.