The UK economy is grappling with a £41.2bn miss in balancing day-to-day spending. Despite strong Q1 GDP growth, recent signs of a slowdown and rising inflation complicate the Bank of England’s decision on interest rates. The FTSE 100 has performed well recently, but concerns over the services sector and staffing cuts persist. Meanwhile, global markets have seen some improved stability following trade negotiations, especially with the US and EU.

UK policy

The British economy continues to face significant challenges in 2025. A recent study by NIESR (the National Institute of Economic and Social Research) found that the Government is set to miss its borrowing target by £41.2bn.

The implications of this are significant. If Chancellor Reeves wants to bring back the £9.9bn worth of headroom created in the 2024 Autumn Budget, she will need to cut spending and/or raise taxes by £51.1bn.

As such, there is rising speculation that this year’s budget will eclipse last year’s in significance. Backbench rebellions have plagued the Government so far over attempted budget cuts, as seen in the Prime Minister’s recent welfare reform bill (which was watered down).

With such resistance in place from Labour rebels, it looks increasingly likely that further tax rises could arrive later this year. Attempts to change borrowing rules could risk a “Liz Truss moment” (when bond markets fell over fears of unfunded tax cuts).

If the Chancellor relies on raising taxes to fix the new £51bn black hole, it would be equivalent to raising the basic and higher rates by 5%. However, due to the government’s commitment to not raise taxes on “working people”, the Chancellor will be significantly constrained in her taxing options.

The UK economy

The UK economy booked solid GDP growth in the first quarter (Q1) of 2025, achieving a faster-than-expected 0.70%. Nonetheless, more recent figures suggest a slowdown.

So far, estimates show that the economy contracted in April and May. Indeed, the figures from earlier months could largely be attributed to a surge in exports as firms tried to get ahead of US tariff impositions. April also marked the end of a stamp duty holiday, causing buyers to surge their transactions in March.

Inflation remains above the Bank of England’s (BoE) target of 2%, currently standing at 3.60% for June (up from 3.40% in May). This will hang over the Bank’s meeting in August, when it will decide on whether to cut, hold or raise interest rates.

The BoE faces a difficult balancing act. Lowering rates may be necessary to support economic growth. However, doing so could add further inflationary pressures.

The UK market

The FTSE 100 (the UK’s leading index) had a strong month, rising to over 3% between 6 – 31 July. Notable risers included Smith & Nephew plc (+15.34%), Melrose Industries plc (4.89%) and Fresnillo (6%).

BP received a boost after announcing the discovery of oil and gas in the deepwater offshore Brazil. Shares in lenders also rose after a Supreme Court ruling on motor finance, with Lloyds Banking Group (one of the most exposed names) rallying 8%.

However, headwinds are pushing against the UK market. Orders in the services sector recently fell at the fastest pace since the 2022 Liz Truss “Mini Budget”, with concerns weighing heavily over business prospects and confidence about the global economy.

UK services are highly dominant, representing 80% of the country’s total gross value added (GVA). Some relief might come if fears over high tariffs prove unfounded, and if an interest rate cut helps to boost consumer spending.

Staffing cuts have also occurred at the fastest pace in 6 months as pressures mount on UK businesses. Employer National Insurance (NI) went up in April, and the Government is planning legislation that will make it harder to sack a new employee within their first two years of service.

The Global Outlook

US President Trump unsettled markets earlier this year when he announced sweeping tariffs in April (Liberation Day). Since then, investors have taken comfort in various delays and trade deals – leading to the emergence of a new phrase to describe this brinkmanship – TACO trade (Trump Always Chickens Out).

An example: the initial 90-day pause on tariffs was originally meant to last until the start of August. However, with August now well underway at the time of writing, a series of deals are underway using varying base-level tariffs in the 10-20% range.

As a result, many global market indices have rallied. The Nikkei 225 is a case in point, rising after Trump announced a “Massive” trade deal between the US and Japan. Indeed, 14 nations were given more time to negotiate with the US as the trade deal deadline loomed.

Regarding the EU, market instability occurred in mid-July on the pan-European Stoxx 600, when President Trump threatened a 30% tariff in August. A baseline tariff was eventually agreed on 28 July, set at 15% for goods imported to the US.

There was good news in the eurozone as the European Central Bank (ECB) finally hit its 2% inflation target. This is despite successive cuts to the base rate over the last 12 months, taking it from 4% to 2%.

The content in this article was correct on 1st July 2025

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