After the UK economy's stellar growth in Q1, why does pessimism surrounding the near-term outlook persist

The UK's +0.7% (q-o-q) growth rate in Q1 was by far the strongest of the G7 economies that quarter, and the second fastest rate since emerging from the dark days of lockdown in 2021. Yet, despite smashing expectations, GDP growth forecasts have barely budged from paltry estimates of around 1% this year, and 1.5% next year. Why hasn't the news ushered in a newfound wave of optimism?

Part of the answer lies in what was driving growth that quarter. Namely, a rush of exports to beat Trump’s ‘Liberation Day’ tariffs in April. With businesses having frantically front-loaded the production and shipping of goods to avoid these penalties, we’d expect payback this quarter as orders wind down.

Persistent economic challenges

At the same time, many factors weighing on the UK outlook persist. Both the Bank of England and the IMF have cited external conditions (read: Trump’s tariff threats) as the main source of uncertainty, aggravating the reluctance of domestic businesses to invest. Excessive borrowing and inflation also remain problematic, as evidenced by the interest premium placed on UK government debt over its rich-world peers.

Given that the favourable circumstances of the first quarter are unlikely to be repeated, and that fundamental concerns remain, where might future growth come from?

One promising area has, counter-intuitively, been trade. The UK has been proactive in securing new deals with the US, as well as the EU and India. Consequently, the UK has been relatively insulated from Trump’s ire, providing a leg-up over its peers. Yet, the carve outs and mutual exchanges in these deals are narrow in scope, providing only minor benefits to the economy over an extended period.

Disappointing data

In the meantime, early data for the current quarter has been disappointing. In April monthly GDP contracted by 0.3% (m-o-m) after exports slumped. This confirms that swift payback from the previous splurge is already underway. Just as concerning have been developments in the labour market, as payroll employment declined by 55,000 in April, and by an additional 109,000 in May. Shortfalls were concentrated in hospitality and retail, coinciding with the heavily-criticised double whammy of employers’ national insurance and minimum wage hikes in April.

Limited impact of government and central bank action

Is the government doing anything to counter that misstep? Unfortunately, the centrepiece of this week’s spending review was to commit ever more funding to the money pit that is the NHS. Increased Defence spending, meanwhile, will do little to kick-start the dynamism of the economy, whilst new investments in nuclear will take decades to realise. Concerned businesses and families found little to cheer in these announcements. Furthermore, economists have warned that the additional borrowing will inevitably mean more tax rises in autumn’s Budget.

Will the Bank of England save the day with a more aggressive program of rate cuts? Unlikely. The MPC was utterly divided at its most recent meeting, with a three-way vote split over its policy position. Both the Bank's governor and chief economist have since stressed that stubborn above-target inflation remains their overriding concern, not growth, and that any further policy loosening must be gradual. Rebounding oil prices after the latest ructions in the Middle-East will not help matters.

Conclusion: Justified gloom

Ultimately, in the absence of Q1’s one-off gains, it's a struggle to see where sustained growth will come from. In these circumstances, the gloomy forecasts remain justified.