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Is the UK Economy on the Brink of Stagflation?

Is the UK Economy on the Brink of Stagflation?

After two months of contraction, the UK economy has finally recorded growth, with GDP rising 0.1% in November. While this modest improvement signals resilience in sectors like hospitality and construction, it falls short of market forecasts and underscores the broader challenges facing the economy.

With persistent inflationary pressures, declining business confidence, and looming tax hikes, the question remains about whether this recovery can be sustained or whether the spectre of stagflation – a combination of high inflation and rising unemployment- is approaching.

A Fragile Recovery Signaling Encouraging Signs?

The Office for National Statistics (ONS) reported that GDP grew by 0.1% in November, driven by an uptick in trade for pubs, restaurants, and construction. While this growth is a welcome sign for the government after months of economic turbulence, it remains below the 0.2% forecasted by analysts. Over the three months leading up to November, the economy registered zero growth.

The unexpected drop in inflation to 2.5% in December has brought some relief, triggering the fastest decline in government borrowing costs in nearly two years. However, economists remain cautious.

Hailey Low, an economist at the National Institute of Economic and Social Research, said the sluggish growth raises “concerns over the UK’s economic outlook moving into 2025.”

Rob Wood, Chief UK Economist at Pantheon Macroeconomics, added that “tax hikes announced in the Chancellor’s October Budget and global uncertainty around Donald Trump’s potential tariffs on trade with the US have dragged the economy into stagnation.”

While the return to growth may ease fears of immediate recession, it highlights the fragile state of the economy rather than signalling a robust recovery.

Declining Business Confidence and Policy Backlash

Business confidence has fallen to its lowest point in two years, driven by fears over the Chancellor’s latest tax measures. Employers’ National Insurance contributions are set to rise to 15% in April, up from 13.8%, while the earnings threshold for the tax will drop from £9,100 to £5,000. This amounts to a £25 billion tax increase on businesses, sparking alarm among employers.

Retailers, in particular, have claimed to feel this the worst, with fears that these additional costs will reduce businesses’ capacity to offer pay rises or create new jobs. Employers warn that rising costs, coupled with minimum wage hikes, could further restrict economic growth.

Chancellor Reeves defended her decisions, claiming the government is “generating investment, driving reform, and [has] relentless commitment to root out waste in public spending.” However, critics argue that these measures risk stifling recovery by imposing additional burdens on already struggling businesses.

Starmer’s Balancing Act

The political ramifications of the UK’s economic stagnation are becoming increasingly apparent. Chancellor Reeves has faced criticism from both business leaders and opposition parties over her handling of the budget and broader economic strategy. Despite this, Prime Minister Keir Starmer has expressed “full confidence” in Reeves, although he notably avoided confirming whether she would remain in post until the next general election. This was soon rectified by the Prime Minister’s spokesmen claiming the pair will work together throughout the whole of this parliament.

Prime Ministers are often reluctant to give guarantees about the futures of individual Cabinet members as they need to have flexibility to respond to events and reshuffle their team.

Trade Tensions and Global Risks to the UK Economy

Adding to the UK’s domestic challenges is the prospect of a potential trade war with the United States. As Trump is set to enter office next Monday, his policy of tariffs on UK exports have unsettled markets and cast a shadow over the economic outlook.

Such geopolitical uncertainty compounds the challenges posed by stagnant growth and rising business costs. Economists warn that these external pressures could further hinder the UK’s ability to recover in a volatile global environment.

A Call to Action

Amid these challenges, Chancellor Reeves has urged regulators to prioritise economic growth. She has claimed the government’s policies are designed to “restore stability and foster long-term prosperity.” Yet critics argue that these efforts fail to address the deeper structural issues holding back the economy.

The November growth figures, while welcome, offer little reassurance for businesses and consumers grappling with high costs and declining confidence. Without bold and coordinated policy interventions, the risk of stagnation – or worse, stagflation – remains significant.

Final Thought

The UK economy’s return to growth after two months of contraction is a promising sign, but it’s far from a turning point. The broader economic context – stagnant quarterly growth, falling business confidence, and looming tax hikes – paints a troubling picture of fragility.

However, the unexpected decline in inflation to 2.5% provides a rare bright spot, suggesting that price pressures may finally be easing. This drop has also triggered a decline in government borrowing costs, offering some breathing room for policymakers to focus on stimulating growth. If this trend continues, it could lay the foundation for a more stable recovery in 2025.

Politically, the government faces immense pressure to demonstrate that its policies can deliver meaningful and sustained recovery. Failure to address the root causes of stagnation could deepen public dissatisfaction and further erode confidence in the UK’s economic future.

The road ahead will require a careful balancing act: fostering growth while maintaining fiscal discipline, supporting businesses while ensuring public services remain funded, and navigating global uncertainties without losing sight of domestic priorities.

For more of Chamber UK’s economic analysis, please click here.

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