Slowing economic growth, combined with persistent inflation, is likely to undermine Rachel Reeves’ budget plan, possibly leading to more tax increases in the fall.
The National Institute for Economic and Social Research (NIESR) pointed out that the UK has been facing long-term stagnation, which has reduced tax revenues and complicated budget balancing since the tight fiscal measures announced in March, including cuts to welfare benefits.
NIESR suggested that the issues plaguing the UK economy this year are largely the result of government actions rather than external factors, primarily due to declining global trade.
Current projections indicate that the UK economy will grow by 1.2% in 2025, a reduction from an earlier estimate of 1.5%.
Concerns about potential tax hikes in the fall are considered to weigh more heavily on business investment than the uncertainties linked to tariffs from the U.S.
The report noted, “While global factors, such as recent U.S. tariffs, have disrupted international trade, domestic issues are the main contributors to the sluggishness of the UK economy.”
Higher than anticipated inflation paired with slower growth will complicate the Bank of England’s position ahead of its next interest rate decision.
Policymakers are expected to meet on Thursday, where a decrease in interest rates by 0.25% to 4.25% is anticipated. However, there are concerns that inflation may persist longer than expected, which could stall future rate cuts.
While financial markets are hopeful for at least two more reductions, NIESR predicts just one additional cut in 2025 after a quarter-point decrease in May.
Benjamin Caswell, an economist with NIESR, mentioned that the manifesto restricting the Treasury from increasing borrowing and raising taxes has created a situation where burdens on households and businesses limit economic growth.
“Given the weak economic outlook, the government is unlikely to meet its fiscal objectives,” he asserted.
Throughout this five-year parliamentary session, Reeves has committed to lowering overall debt as a percentage of national income while also maintaining current levels of governmental expenditure.
NIESR forecasts that the annual deficit, currently capped at £9.9 billion, is projected to rise to £62.9 billion by 2029-30, which may prompt increased borrowing or additional cuts to spending.
Overall liabilities are expected to climb from 88.8% to 89.5% of GDP, and there will be a rise based on new measures of public sector net financial liabilities (PSNFL).
The think tank indicated that further budget cuts might be necessary in the fall, a situation that could concern Labour MPs as they prepare for stringent spending reviews.
Caswell noted that the need to restore that narrow £9.9 billion margin has left many businesses uncertain about October’s financial landscape, particularly if further tax increases occur. Companies seem to be waiting and “playing the game.”
“As a result, they’re scaling back investments and hiring. Job vacancies have plummeted sharply. Based on business surveys, we might see another repeat of what happened in March,” he added.
Stephen Millard, NIESR’s Interim Director, stated that the Prime Minister’s self-imposed fiscal rules have led to a scenario where tax increases must be announced twice a year, lacking alternative savings or facing political repercussions.
This uncertainty contributes to reduced investments and sluggish growth, which is contrary to the government’s intentions. “We need to reevaluate our financial framework,” he urged.
The organization’s economic outlook suggested an uptick in inflation over the coming year, predicted to average 3.3% in 2025 after hitting a peak of 3.7%. This is a shift from previous estimates where inflation was expected to average 2.4% with a peak of 3.2%.
With diminishing domestic investment and the impact of U.S. tariff policies weighing on global growth, the UK’s economic expansion is losing momentum, according to NIESR.
Last month, the International Monetary Fund revised its UK growth forecast down by 0.5 percentage points, bringing it to 1.1% for this year.
A spokesperson for the Ministry of Finance responded, saying, “Our commitment to sticking to fiscal rules is unwavering, and we’ve seen the consequences of a government that rushes its financial decisions.”
They emphasized that steps have been taken to amend fiscal matters and restructure the NHS while managing to reduce reservations and waiting lists for five consecutive months, aiding in protecting worker salaries against rising taxes.
