US tariffs, tax hikes to depress UK growth this year and next, CBI forecasts show

The Confederation of British Industry (CBI) has significantly lowered its UK economic growth forecasts for 2025 and 2026, now projecting 1.2% and 1.0% respectively, citing headwinds from potential U.S. tariffs under a Trump administration and rising labor costs. These factors are expected to affect firms' hiring and investment plans, potentially increasing prices and reducing profits; the Bank of England estimates Trump's tariffs will reduce annual output by 0.3% in three years. The CBI anticipates the Bank of England will gradually cut interest rates to 3.5% by late 2025, with household spending driving growth in 2026 as inflation cools.

Analysis

The Confederation of British Industry (CBI) has materially revised down its UK economic growth forecasts, projecting a slowdown to 1.2% for the current year (down from 1.6% predicted in December) and further to 1.0% in 2026 (down from 1.5%). This dimmer outlook is attributed to significant headwinds, primarily potential U.S. tariffs under a Trump administration and rising domestic labor costs, including increased social security contributions and the minimum wage, which are impacting firms' hiring and investment intentions, and are anticipated to exert upward pressure on prices while eroding profits. The CBI notes that these forecasts were formulated prior to the recent escalation in Middle Eastern conflict, the impact of which on oil prices and UK inflation is being monitored. U.S. tariffs are a particular concern, with the Bank of England estimating they could reduce UK annual output by 0.3% within three years, though the CBI assumes the direct impact will be limited as U.S. goods exports constitute about 7% of total UK exports. Inflation is expected by the CBI to remain above the Bank of England's target this year, influenced by higher energy and water bills, before moderating to 2.5% in 2026. Consequently, the CBI foresees a gradual easing of monetary policy, with the Bank Rate projected to fall from 4.25% to 3.5% by late 2025 as wage growth weakens. Economic growth in 2026 is anticipated to be primarily driven by a pickup in household spending, contingent on cooling inflation and lower borrowing costs. Measures from finance minister Rachel Reeves' recent Spending Review are not expected to significantly impact growth in 2025 or 2026, though long-term benefits are seen.

Key Decisions for Investors

• Investors should consider adopting a more cautious stance towards UK-centric assets given the downgraded economic growth forecasts, persistent near-term inflation, and rising business costs highlighted by the CBI.
• Closely monitor developments related to U.S. trade policy and domestic UK labor cost inflation, as these are identified as primary headwinds with the potential to further impact corporate profitability and investment.
• Factor in the expectation of a slow monetary easing cycle by the Bank of England, with interest rates projected to remain relatively elevated into late 2025, which could continue to dampen valuations for growth-sensitive UK equities and influence fixed income strategies.
• Recognize that a significant uplift in UK economic activity, particularly driven by consumer spending, is likely deferred until 2026 and is dependent on the successful moderation of inflation and borrowing costs.