UK growth to be reined in by public finance squeeze, OECD warns

The OECD projects modest U.K. economic growth of 1.3% in 2025 slowing to 1% in 2026, citing constrained public finances, trade tensions, and tight financial conditions. While the budget deficit is expected to improve, public debt is forecast to reach 104% of GDP in 2026, and the OECD cautions that the government's "very thin fiscal buffers" may be insufficient to address future economic shocks without breaching fiscal rules. Chancellor Rachel Reeves faces pressure to implement further budget cuts in the upcoming Spending Review amid calls from the OECD for a balanced approach combining spending cuts, revenue-raising measures, and labor market reforms.

Analysis

The Organisation for Economic Cooperation and Development (OECD) projects a challenging economic outlook for the U.K., with growth anticipated to slow from an already modest 1.3% in 2025 to 1% in 2026. This deceleration is attributed to a confluence of factors including constrained public finances, heightened trade tensions, tighter financial conditions, and pervasive uncertainty impacting consumer confidence and business investment. Despite an expected improvement in the budget deficit, forecasted to narrow from 5.3% of GDP in 2025 to 4.5% in 2026, public debt is projected to continue its ascent, reaching 104% of GDP by 2026. This fiscal strain is a key concern, with the OECD highlighting the U.K. government's "very thin fiscal buffers" which may prove inadequate to absorb future economic shocks without breaching its self-imposed fiscal rules. These rules, which Finance Minister Rachel Reeves deems "non-negotiable," mandate that day-to-day spending be covered by tax revenues and that public debt as a share of economic output must fall by 2029-30. The upcoming Spending Review on June 11 is expected to reveal further fiscal consolidation measures, with the OECD advocating for a balanced approach involving targeted spending cuts, revenue-raising initiatives such as re-evaluating council tax bands, and pro-work reforms, while preserving productivity-enhancing public investments. The government has already initiated welfare cuts, employer tax increases, and planning reforms, alongside a defense spending hike to 2.5% of GDP by 2027 funded by reductions in overseas aid, signaling a tight fiscal environment ahead.

Key Decisions for Investors

• Investors should exercise caution regarding U.K.-exposed assets given the projected weak economic growth, high public debt, and tight fiscal constraints, which collectively present a moderately negative outlook.
• Closely monitor the upcoming Spending Review on June 11 for details on further budget cuts and fiscal policy direction, as these will significantly impact the U.K.'s economic trajectory and market sentiment.
• Consider the potential for increased sterling volatility and downside risks to U.K. equities and gilts if fiscal buffers prove insufficient to manage economic shocks or if growth underperforms the OECD's already modest expectations.
• Evaluate investments for resilience against a backdrop of heightened trade tensions and potential further tightening of financial conditions as flagged by the OECD, and watch for any policy shifts that could alter the U.K.'s debt sustainability profile.