UK will slump to 1% growth next year as Trump tariffs bite, says OECD

The OECD has downgraded the UK's economic growth forecast for 2025 from 1.4% to 1.3% and for the next year from 1.2% to 1%, citing the impact of Donald Trump's tariff war on trade and investment, alongside constraints on Whitehall spending and higher inflation. The report highlights a "very thin fiscal buffer" exposing the UK economy to downside risk, echoing concerns previously raised by the IMF. The OECD also cut its global growth forecasts, anticipating a "modest" 2.9% growth for both this year and next, with the US, Mexican, and Canadian economies expected to be most affected by the tariff battles.

Analysis

The Organisation for Economic Co-operation and Development (OECD) has revised its economic growth forecasts downwards for the UK, projecting a reduction from 1.4% to 1.3% for 2025 and from 1.2% to 1% for the subsequent year, primarily attributing this to the adverse effects of US-led trade tariffs on commerce and investment, compounded by domestic constraints on government expenditure and persistently high inflation. This assessment echoes the International Monetary Fund's recent concerns, highlighting the UK's "very thin fiscal buffer" which exposes the economy to "significant downside risk." The OECD's revised global outlook is similarly cautious, now anticipating a modest 2.9% growth for both the current and upcoming year, a downgrade influenced by widespread tariff uncertainties, with the US, Mexican, and Canadian economies expected to bear the brunt; US growth forecasts were cut to 1.6% for the current year and 1.5% for 2026. This pessimistic outlook presents a challenge for UK Chancellor Rachel Reeves ahead of a critical spending review, as government finances are already strained by rising costs in health, pensions, and defence amidst economic stagnation that limits tax revenue growth. The OECD's chief economist, Álvaro Pereira, expressed caution regarding the UK's capacity to navigate the global tariff war—a risk not fully incorporated into the Office for Budget Responsibility's more optimistic March forecast of 1% UK growth this year recovering to 1.9% next year. Pereira indicated forecasts assume key US tariffs (25% on steel, aluminium, cars; 10% blanket tariff) will persist for at least two years, exacerbating trade barriers and policy uncertainty, thereby negatively impacting business and consumer confidence, trade, investment, incomes, and job creation globally. UK inflation is expected to remain "sticky," potentially delaying Bank of England interest rate cuts despite a slowing economy, and in tariff-affected nations, inflation might initially rise before aligning with central bank targets by 2026. Specific UK economic indicators show weakening momentum and deteriorating business sentiment after a 0.7% GDP rise in the first three months of the year, alongside depressed consumer confidence and volatile retail sales, prompting the OECD to urge the UK government to curtail day-to-day spending to preserve fiscal space for public investment and bolster its limited fiscal buffers against substantial downside risks.

Key Decisions for Investors

• Investors should adopt a more cautious stance towards UK-exposed assets, given the downgraded economic growth outlook, heightened fiscal vulnerabilities, and ongoing trade policy uncertainties.
• Closely monitor upcoming UK fiscal policy announcements, particularly the spending review, for signals regarding the government's strategy to manage budgetary constraints and rebuild fiscal resilience in the face of these economic headwinds.
• Re-evaluate portfolio allocations, considering reduced exposure to sectors highly sensitive to international trade disruptions, such as manufacturing and export-oriented industries, and contemplate hedging strategies against potential market volatility stemming from persistent tariff impacts and slowing global growth.
• Factor in the likelihood of sustained inflationary pressures in the UK, which may lead to a slower pace of interest rate cuts by the Bank of England than previously anticipated, impacting valuations for fixed income and interest-rate sensitive equities.