UK economy had a strong start to 2024 with more GDP growth to come

EY ITEM Club Summer Forecast - July 2024

The EY ITEM Club predictions are a significant upgrade from the 0.7% predicted in April’s Spring Forecast and the modest 0.1% GDP growth seen in 2023. The latest forecast also expects this economic momentum to accelerate further next year with 2% GDP growth expected in 2025 and in 2026.

Although the slowdown in wage growth is forecast to persist, real household incomes are expected to continue to rise substantially thanks to lower inflation. The EY ITEM Club predicts Consumer Price Index (CPI) inflation to remain around the Bank of England’s 2% target over the coming years, with an average of 2.5% in 2024, falling to 2.2% in 2025. This is expected to boost household spending power, which in turn is forecast to be the main driver of stronger economic activity for the UK over the next two years.

Lower inflation is also expected to prompt the Monetary Policy Committee (MPC) to reduce Bank Rate to 4.75% before the end of 2024, with the EY ITEM Club predicting that the first interest rate cut will come in September and be followed by a further cut in November. This is a slight downgrade on the Spring Forecast prediction that Bank Rate would fall to 4.5% by the end of the 2024, due in part to ongoing stickiness in services inflation.

Hywel Ball, EY UK Chair, said: “The opening months of 2024 delivered a stronger than anticipated economic performance and, with inflation predicted to remain relatively stable and consumer spending set to climb, growth should continue. The UK’s economic recovery is underway, but it’s expected to be more steady than spectacular.

“Brighter conditions are expected to be matched by a rise in business investment in 2024, followed by an even more significant uptick next year. This would continue the UK’s strong post-pandemic performance in private sector investment and, alongside consumer spending, should be a key driver of national growth going forwards.”

UK consumer spending expected to improve but tight fiscal policy could limit growth

The EY ITEM Club expects solid household income growth and a less cautious approach from consumers going forward, to result in 0.8% growth in consumer spending this year, and 2.5% in 2025.

While prospects for consumer spending appear relatively positive, they are likely to be tempered by the lagged effect of past monetary policy tightening on households. Nearly four million borrowers are set to see mortgage costs rise by the end of 2026 and while this should be manageable for most homeowners, it is still predicted to limit the pace of GDP growth.

Tight fiscal policy is also expected to limit GDP growth. The new UK Government has pledged to follow the existing fiscal rule which requires reducing the public sector net debt-to-GDP ratio in the fifth year of the rolling forecast. This will mean the Government is likely to implement previously planned tax rises and maintain a low level of public sector spending, which could include cutting the level of UK public investment over the next five years.

Peter Arnold, EY UK Chief Economist, said: “Improved consumer spending will help power economic momentum in 2024 and into next year, but government and business spending will also have a significant effect on growth. By upholding the net debt rule and initially presenting a range of relatively modest, fiscally-neutral measures, the new UK government appears to be maintaining the tight fiscal approach established by the previous administration. This will likely keep public investment comparatively low, restraining GDP growth in the short term and limiting growth potential further into the future. The policies unveiled in the coming months, particularly those announced at the Autumn Budget, will determine whether UK GDP exceeds this forecast and moves from restrained to faster levels of growth.

“Combining higher public investment with a concerted effort to build on the UK’s recent success in business investment could provide an economic shot in the arm. The new Government has an opportunity to reassert the UK’s reputation as an appealing, politically stable destination for private sector capital, and investors will likely pay close attention to the coming months of policy discussions, particularly in areas such as planning reform. This has been promised by previous governments, but meaningful change to the planning system could accelerate the rate at which major projects move from concept to construction, providing investors with greater confidence in the UK’s ability to provide timely returns.”

UK business investment outlook continues to brighten

The EY ITEM Club remains positive around business investment prospects. With the Bank of England expected to cut interest rates later in the year, the UK is likely past the peak squeeze from higher debt servicing costs, implying a brightening outlook.

Business investment is now expected to grow by 1% in 2024, up from expectations of 0.6% growth in April’s Spring Forecast. The EY ITEM Club continues to predict more significant growth of 3.2% in 2025, in line with previous expectations.

Risks to UK’s economic forecast

Ongoing geopolitical tensions present a risk to the forecast, with the potential for upside surprises in energy, oil, food and transportation prices as a result, which could increase inflation. Meanwhile, with more than half of the world’s population set to vote in national elections this year, significant policy change could take place in some of the world’s largest economies, with potential knock-on effects for the UK.

Conversely, there is also a possibility that inflation may fall quicker than expected, particularly if the labour market cools more quickly than expected. This could mean that the rate of GDP growth exceeds the predictions made by the forecast.