Unexpectedly high gross domestic product (GDP) growth in the first three months of 2025 led the Chancellor to claim on 15 May that the UK economy is “beginning to turn a corner.”
However, speculation that this GDP growth is unlikely to be sustained, combined with a sharp increase in inflation and economic uncertainty around global trade tariffs, have led some economists to express concerns about the longer-term outlook for the UK economy.
This Insight covers the UK’s GDP performance in the first quarter of 2025, the rise in inflation, as well as the cut to interest rates.
GDP growth beats predictions
The UK’s GDP grew by 0.2% in March compared with February and by 0.7% in January to March 2025 (first quarter, or Q1 2025) compared with October to December 2024 (Q4 2024). This followed growth of 0.1% in Q4 2024 compared with Q3. These trends can be seen in the chart below.
The level of growth in Q1 2025 was higher than many predictions suggested it would be. The Bank of England’s May Monetary Policy Report for May 2025 predicted GDP growth of 0.6% in Q1 2025, while the Treasury’s April survey of independent forecasters showed an average forecast of GDP growth of 0.4% in Q1 2025.
UK growth in Q1 2025 was also high by international standards. GDP in Q1 2025 compared with Q4 2024:
- grew by 0.2% in Germany
- grew by 0.1% in France
- fell by 0.1% in the US
Services and exports drive growth
Services output increased by 0.7% in Q1 2025 compared with the previous quarter and was estimated to have been 1.5% higher than in Q1 2024.
Production output was also up, by 1.1%, with manufacturing output increasing by 0.8% on the previous quarter. Construction output is estimated to have been flat in Q1, following 0.3% growth in the previous quarter.
Within service industries, there was particularly strong growth in administrative and support service activities, as well as in retailing. Feedback from retailers indicated that sunny weather in March (the UK’s third sunniest March on record (PDF)) was partly responsible for boosting sales.
Export growth was also strong, as goods exports increased by 5.6% between Q4 2024 and Q1 2025, while services exports grew by 2.0% over the same period.
Note that early estimates of GDP are subject to revision (both positive and negative) as more detailed information becomes available.
Potential tariffs generate uncertainty
Some economists predict that the relatively positive start to the year is will not continue.
The Bank of England’s Monetary Policy Report for May 2025 suggested headline GDP figures for Q1 were likely to be “significantly above the estimated pace of underlying growth” (which it estimated to “have been around zero”), predicting headline growth of 0.1% in Q2 2025.
Data on economic activity for the first quarter of 2025 also does not capture the effects of higher American tariffs announced in early April. Survey data indicates this has already had a negative effect on UK business sentiment and activity.
The S&P Global UK Manufacturing Purchasing Managers’ Index (PMI) release from 1 May 2025 reported a fall in UK manufacturing production in April 2025. This was in part attributed to a decline in export orders, which fell at “the quickest pace in almost five years” as increased uncertainties, including prospective US tariffs, had “drained confidence from both consumer and business-to-business clients.”
Similarly, the S&P Global UK Services PMI release from 6 May 2025 reported a “marginal downturn in business activity” in the UK service industries, as well as a fall in exports, with total new work from abroad “decreasing at the fastest pace since February 2021.” The Office for National Statistics (ONS) has also indicated that export growth in Q1 2025 could in part have been a result of pre-emptive trade ahead of potential future tariffs. Noting an increase in UK–US trade in March 2025, the ONS indicated that this could be “a sign of changing trader behaviour ahead of tariff introduction.”
Inflation reaches highest level in over a year
Inflation, as measured by annual change in the Consumer Prices Index (CPI), was 3.5% in April 2025, up from 2.6% in March. This is the highest rate since January 2024. This can be seen in the chart below.
The largest contribution to the increase in the inflation rate was from housing and household services, due to the increased gas and electricity prices which resulted from the increase to the energy price cap in April 2025.
The price of electricity, gas & miscellaneous energy increased by 7.5% in April 2025 compared with April 2024. There were also increases in the rate of core inflation (which excludes food and energy), which rose from 3.4% to 3.8%, while services inflation rose from 4.7% to 5.4%.
UK inflation was high compared with EU and Eurozone inflation in April 2025: inflation in the EU was 2.4%, while inflation in the Eurozone was 2.2%.
UK inflation is also predicted to remain elevated in the immediate future. The Bank of England has predicted that inflation will reach 3.5% by Q3 2025, driven by ongoing energy price increases, before falling to the Bank’s 2% target by Q1 2027.
The Bank of England’s Monetary Policy Report for May 2025 also suggested that US tariffs are expected to have some effect on future UK inflation, saying higher tariffs “will weigh slightly on UK inflation”, predicting an increase of “0.2 percentage points in two years’ time and by 0.1 percentage point in three years’ time.”
Divisions over interest rates
On 8 May 2025, the Bank of England’s Monetary Policy Committee (MPC) cut interest rates by 0.25 of a percentage point, to 4.25%. Interest rates are now at their lowest level in two years, following the MPC’s second rate cut this year, which is also its fourth in the last 12 months.
The MPC cited “substantial progress on disinflation over the past two years”, which has allowed for recent cuts, while maintaining rates in “restrictive territory” to “continue to squeeze out persistent inflationary pressures.”
Despite the series of recent cuts to interest rates, the MPC remains divided on the issue. Five of the MPC’s nine members voted for the most recent cut, two voted for a larger 0.5 percentage point cut, while two voted in favour of no change.
Huw Pill, the Bank of England’s chief economist, was one of those MPC members who voted for no change.
In a briefing on the monetary policy outlook held on 20 May 2025, Pill argued that rate reductions should be “cautious”, and that the recent pattern of cuts had been “running a little too fast” in light of progress made in returning to the 2% inflation target. Pill went on to argue that implementing this cautious approach will require a “skip” in the recent pattern of quarterly cuts to interest rates at some point.
A counterargument, expressed by MPC member Alan Taylor, who voted for a 0.5% cut in rates and has argued for a “a lower [monetary] policy path” is that interest rates remain high and that the recent increase in inflation was driven by “one-time tax and administered price changes” such as increased energy and water prices, that had been widely anticipated.
Better news for borrowers
Lower interest rates have fed through to mortgage rates. The average rate for a new two-year fixed-rate mortgage was 4.43% in April 2025. This is the second-lowest average level for a two-year fixed mortgage since the September 2022 mini-Budget. This can be seen in the chart below.
Reports indicate that lenders are offering fixed mortgage deals with interest rates under 4%, amid increased levels of competition between mortgage lenders.
About the author: Matthew Ward is a researcher at the House of Commons Library, specialising in economic policy and statistics.
Photo by: Colin via Wikimedia Commons
