A closer look at the UK economy – and the implications for investors

We’ve seen a lot of noise in financial markets and the global economy over the past few weeks. We wanted to take a closer look at what’s been happening in the UK — and what it could mean for investors.

On the economic side, trade tariffs and policy uncertainty look set to impact global growth. The most recent forecasts from the International Monetary Fund (IMF) suggest that the global economy could grow by 2.8% in 2025, down from their October forecast of 3.3%.

US tariffs on UK businesses have been lower than those imposed on many other countries, but the UK should still be impacted by an overall slower global environment. The IMF reduced its forecast for UK growth in 2025 from 1.6% in its October 2024 outlook to 1.1% in April. It’s even more difficult than usual to make these forecasts, given how quickly some of these trade policies can change.

We may have already seen some of this uncertainty reflected in macro data. The latest Purchasing Managers (PMI) Survey for April came in below expectations. Interestingly, that was because of weaker than expected services indicators, rather than manufacturing. It’s also worth noting that the PMI is a sentiment indicator rather than actual hard data, although it has been a useful indicator of underlying activity. 

Slower growth creates more challenges for the government. After the Spring statement, it was clear that the government didn’t have a lot of headroom against its own fiscal rules. Higher trade barriers and slower growth will likely result in less tax revenue than previously forecast. That leaves the Chancellor, once again, in a difficult position. Proposed cuts to welfare spending are already causing unrest within the Labour party, raising the prospect of higher taxes at the October budget.

As we’ve noted before, the tax burden in the UK is already high compared to history, and is forecast to rise further, as you can see in the chart below from the Institute of Fiscal Studies. 

At the same time, anecdotally, there’s a steady drumbeat of stories of wealthy UK residents moving their tax residences overseas – particularly in response to inheritance tax. Individual stories might not matter that much, but it’s worth noting that the UK tax base is relatively narrow. According to the Taxpayers Alliance, the top 1% of income tax payers paid 28% of all income tax. If those figures are accurate, it may take fewer departures than expected to see a meaningful impact on the fiscal accounts.

It’s reasonable to ask if the government might consider easing its fiscal rules – particularly the target of balancing the current budget by 2029/30 – citing exceptional circumstances. So far, the Chancellor and the Prime Minister have ruled out such a move, with the Liz Truss experience still very much in the background. But, if macro data worsens as we go through the summer, we might see some more flexibility in the Autumn. 

Higher trade tariffs also represent a challenge for the Bank of England. As we’ve said, we think tariffs will slow down growth, but could also cause prices to rise. The question for central bankers is whether these higher prices will cause inflation to re-accelerate, or if they’re simply a one-off. We currently believe that tariffs will probably cause a one-off shift to prices and that inflation could moderate on the back of weaker domestic demand. That should support lower policy rates in the coming quarters. 

On the financial markets side, the news is a bit better. UK equities have generally held up quite well in the recent market volatility. We think this reflects lower starting valuations and perhaps the more defensive earnings profile of some of the large UK-listed businesses. On the fixed income side, UK government bond yields have been quite volatile – along with the rest of the developed world – but 10-year yields are roughly where they were at the start of the year. 

What does it mean for portfolios? Our UK portfolios continue to hold an overweight in UK equities relative to a simple market-cap weighted equity ETF. That has helped over the past few months, as UK equities have outperformed their US peers. We continue to see merit in fixed income in a difficult macro environment, with short-dated UK government bond yields at close to 4%.

We continue to believe that it’s important to maintain a well-diversified portfolio, particularly in an uncertain environment. It’s tempting to be more active when markets are volatile, but we continue to believe most investors are better served by taking a long-term approach rather than trying to chase daily market moves.