Economic Overview
The outlook for 2025 looks increasingly complex and challenging compared to where we were in Q4 2024. The Bank of England's latest projections (6th Feb) suggest a gradual recovery in GDP growth from mid-2025, but significant new headwinds in the near term warranted a halving of their November 2024 GDP forecast.
They have also increased the scale of the anticipated 'dead-cat-bounce' in inflation this year by roughly 100 basis points, forecasting CPI to now peak at 3.7% by Q3 2025. This combination of a slowing economy and rising inflation is usually an economist's and Chancellor's worst nightmare – yet worryingly, stagflation is now a genuine concern.
Several factors will determine whether this situation can be avoided. The nature of the impact of the Autumn Budget's tax and spending measures, particularly the increase in employer NICs and minimum wage changes, will likely constrain business investment and hiring decisions. This is especially true in sectors dependent on lower-wage and//or high-volume staffing levels (Retail, Hospitality, Construction, etc.).
Business surveys conducted since the Budget indicate that most firms intend to cover the extra labour costs through a combination of price rises and hiring freezes//staff cuts. Both of these will, in terms of scale, have an as-yet-unknown negative impact on inflation and consumer demand.
Additional pressures on debt costs from the Bank's active Quantitative Tightening stance, combined with the higher public-sector appetite for borrowing, will likely place continued upward pressure on longer-term commercial funding costs. At the same time, any divergence between UK monetary policy and the US & ECB could push sterling higher, potentially adding to imported price inflation. This could also be the result if UK interest rates remain higher for longer due to more persistent domestic inflation pressures. Coupling this with rising trade tensions and protectionist measures creates additional uncertainty and downward drag on the UK economy.
While the labour market remains relatively robust, the projected rise in unemployment to 4.75% suggests a gradual moderation of upward wage pressures. However, the strong labour market and real wage growth have been the one saving grace for the economy through the cost-of-living and inflation crises. Were the labour market to slow too far too quickly, we could start to see a major risk of recession.
No surprise then that Andrew Bailey, the Bank of England governor, highlighted that the MPC has now added a new descriptive word to their formal characterisation of their strategic policy approach – 'careful' has now been added alongside the existing term: 'gradual'.
Markets had been translating the MPC’s 'gradualism' into the expectation that rates would be slowly eased by 0.25% three or four times in 2025. However, the formal addition of the word 'careful' implies a new hawkish stance to the Bank's apparent broader thinking which could reduce the scope for future cuts.
“The strong labour market and real wage growth have been the one saving grace for the economy through the cost-of-living and inflation crises. Were the labour market to slow too far too quickly, we could start to see a major risk of recession.”
Given the upside risks now emerging, both to underlying inflation and the broader macroeconomic picture, this new caution is perhaps justified. As 2025 unfolds, there is a growing sense that major shifts in the global political and fiscal landscape are likely to emerge at some stage, which will confound the historic trajectory of markets and policymakers' expectations.
On a more positive note though, we started last year on a similarly cautious and slightly downbeat note yet ended 2024 with resurgent commercial and residential investment activity as certainty and optimism returned. The scale of the Autumn Budget did come as a surprise and put a pin in some plans while the subsequent bump in debt costs and fine details were digested. However, there remains a deep pot of 'dry powder' still looking to invest in UK real estate in 2025.
Real estate professionals in the 2020s could therefore be forgiven for feeling like Sisyphus, eternally pushing a boulder uphill only to see it roll back down as the New Year comes back around.
Fortunately, our industry shares the Greek legend’s apparently bottomless resilience and determination. Just like 2024, we expect activity levels and conditions to improve as the year unfolds and the current uncertainties and risks either translate into new realities or fade out of view. Further rate cuts in Q2 and Q3, combined with any action by the Government to improve short-term growth prospects, would smooth the path even further.
“There remains a deep pot of 'dry powder' still looking to invest in UK real estate in 2025.”