Economic update: the UK economy faces a difficult road ahead

As reported by ICAW

The UK economy is feeling the effects of growing domestic and international headwinds as GDP slows and inflation continues to rise. ICAEW’s Economies Director Suren Thiru discusses the implications.

After a strong start to the year, the UK economy is beginning to feel the strain of rising business costs, with momentum slowing. Although growth in the second quarter of this year was better than expected, a sharp deceleration from the first quarter highlights the impact of higher labour costs, global trade turbulence and lingering structural weaknesses.

While the services and construction sectors showed some resilience, the combination of weaker industrial output, subdued business investment and softening consumer demand point to a more fragile outlook. With inflation edging higher and policymakers split on how best to respond, the question is whether the UK economy can absorb these cost pressures – or whether it risks slipping into a more prolonged slowdown in the months ahead.

UK economy feels the impact of higher business costs

Official figures revealed that UK GDP grew by 0.3% in the second quarter of 2025 (see Chart 1). While this is better than expected, it marks a sharp decline from growth of 0.7% in the previous quarter as ‘awful April’s’ surge in costs and the explosion of global trade turbulence started to bite.

Following the bumper first three months of 2025, this second quarter slowdown offers a more authentic insight into the UK’s underlying growth path, given persistent problems with anaemic productivity and poor public finances. Monthly GDP is estimated to have grown by 0.4% in June, following successive declines of -0.1% in May and April.

Notable differences in sector performance

The service sector was the biggest contributor to GDP growth in the second quarter, growing by 0.4%. Eight of the 14 services subsectors contributed positively to growth with information and communication firms (which includes computer programming) the largest positive contributor. Output from the construction sector grew by 1.2% in Q2, compared with 0.3% in Q1. In contrast, industrial production fell by 0.3% in the latest quarter, following a 1.3% increase in Q1, partly reflecting its exposure to the combined impacts of April’s jump in labour costs and global trade volatility.

Government spending helps prop up economy

The biggest increase in expenditure in the economy in Q2 2025 came from government expenditure (see Chart 2), which rose by 1.2% in the quarter amid higher outlays on health and public administration and defence as the spending announced in the 2024 Autumn Budget started filtering through into the economy. In contrast, business investment fell by 4.0% in Q2 as the explosion of global economic and geopolitical uncertainty in the quarter pushed more businesses to hold off spending. Consumer expenditure was similarly downbeat, growing by just 0.1% in Q2.

UK exports to US fall to three-year low 

Exports of UK goods to the US decreased by 14.5% to £3.9bn in June 2025, the lowest level since February 2022 and have remained relatively weak since the introduction of US tariffs in April. The latest average effective US tariff rates (that is the average tariff paid across all US imports), show the current impact of Trump’s tariffs on the UK. While still significant, the impact is currently much lower compared with most other countries (see Chart 3). US tariffs have added notable complexity to the UK’s trade outlook. While costs for UK businesses may rise, there is also the possibility of greater imports from countries such as China, as Chinese exporters look to redirect goods to alternative markets outside the US.

UK inflation accelerates

Official figures indicate that UK inflation rose from 3.6% in June to 3.8% in July, the highest rate since January 2024. The largest upward pressure on the headline rate came from air fares, which rose by 30.2% between June and July, marking the biggest increase since records began in 2001, due partly to the timing of school summer holidays. Food prices rose by 4.9% in July, the highest rate since February 2024 and up from 4.5% in June. While spiralling business costs and food prices may mean that inflation peaks above 4%, it should start decelerating in the autumn as a weaker economy increasingly bears down on prices. 

UK interest rates cut to 4%

The Bank of England cut interest rates from 4.25%, to 4.00%, the lowest level since February 2023, but still well above the decade average of 1.32%. Although the Monetary Policy Committee (MPC) eventually voted 5-4 in favour of this outcome, the meeting minutes revealed that, for the first time in MPC history, the committee had to hold two rate votes after a deadlocked initial ballot. This historically close vote split suggests that policymakers are struggling to balance supporting a weakening economy with keeping a lid on rising inflation, inevitably casting doubt on further rate cuts this year. 

Implications for accountants, business owners and the economy

Overall, economic indicators suggest that despite stronger government investment, the UK’s economic performance over the remainder of this year is likely to be modest, with higher inflation and anxiety over more tax hikes in this Autumn’s Budget likely to mean growing reluctance among both consumers and businesses to spend.

UK economy – what to watch for next month:

1. The monthly GDP data to be released on 12 September should confirm that UK GDP growth slowed in July following June’s robust reading of 0.4%.

2. The inflation figures for August due out on 17 September could see a slight increase in the headline rate from the latest reading of 3.8% in July.

3. On 18 September, the MPC is likely to keep interest rates on hold at 4%.