OECD lowers UK growth projections, proposes increased taxation
UK Economy Outlook: Takeaways from the OECD Report
The UK economy is anticipated to grow at a sluggish pace for the coming years, primarily due to Trump's trade wars and rising global costs, as per an OECD report. The forecasted growth rate for 2025 and 2026 is now 1.3% and 1%, respectively - a significant drop from the previous predictions of 1.4% and 1.2%.
The OECD notes that Britain's economic momentum has weakened, and business sentiment is plummeting prompting a rapid erosion of consumer confidence. The strain on the economy is further intensified due to increasing interest payments on government debt.
Donald Trump's tariffs are incorporated into the downgrade of growth expectations. One critical factor is the surge in the aggregate effective tariff encountered by British goods exported to the USA, which has increased by almost 8 percentage points since the commencement of the year. These elements together will undeniably "significantly weigh on growth."
Regardless of the dismal growth prediction, the UK will still grow faster than some major economies such as France, Germany, and Japan.
The global economy's overall expectations have also been reduced by the OECD, now estimating growth of 2.9% in 2025 and 2026 - marking the first time growth less than 3% has been anticipated since the COVID-19 pandemic.
Chancellor Rachel Reeves' Fiscal Rules Under Fire
The OECD has also criticized the UK's self-imposed fiscal rules, asserting that chancellor Rachel Reeves' strict adherence to these rules presents a "significant downside risk" to the country's economic outlook. The OECD warns that rigid fiscal rules create mere "fiscal buffers," which could be "insufficient" during the event of renewed adverse shocks to the economy.
The UK's fiscal rules require that the current budget should be on course to be in balance or surplus by 2029/2030, net financial debt should decline as a share of the economy in 2029/2030, and expenditure on social security and approximately half of welfare spending should remain below £194.5 billion by 2029/2030.
Economists and commentators argue that these rules needlessly restrict the public finances due to their tight limitations on borrowing amounts. The Office for Budget Responsibility (OBR), the UK's fiscal watchdog, currently predicts fiscal headroom of just £9.9 billion resulting from Reeves' follow-through on the fiscal rules.
To alleviate stress on these "thin fiscal buffers," the OECD recommends strengthening public finances "by delivering on the government's ambitious fiscal plans, including through the forthcoming spending review." They advise a balanced approach to the public finances that should encompass some spending cuts, closing tax loopholes, and raising some taxes.
Measures for raising revenue include "re‐evaluating council tax bands based on updated property values" and eradicating "distortions" within the tax system. Additionally, the OECD encourages the government to boost investment and revive productivity growth by focusing on supply-side policies.
The UK Treasury is expected to be sensitive to concerns about diminished fiscal headroom when publishing findings from the UK's spending review, set to be revealed on June 11. This review will determine the budgets of each governmental department for the subsequent three years; however, slow economic growth could complicate matters for Treasury officials as they aim to discover funds without imposing taxes.
On May 28, the IMF proposed potential adjustments to the fiscal rules to prevent frequent spending cuts or tax increases, which might offer some political cover to change them in an impending fiscal event.
The chancellor had previously characterized the fiscal rules as "ironclad," and during the election campaign, she pledged that they would not be altered.
Insights:
- The OECD report substantiates that Trump's trade wars are contributing to the UK's economic woes, but they emphasize that other factors like global trade battles and uncertainty are also key concerns.
- Critics contend that the UK's rigid fiscal rules unnecessarily restrict government spending, and the OECD warns that these rules create fragile fiscal buffers.
- To balance the public finances, the OECD suggests implementing targeted spending cuts, closing tax loopholes, and raising some taxes alongside boosting investment to drive productivity growth.
- The table below provides an overview of crucial impacts and potential mitigation measures for the UK economy:
| Impact Area | Description | Potential Mitigation Measures ||---------------------|-----------------------------------------------------------------------------|------------------------------------|| Trade Disruptions | Uncertainty and trade barrier implications | Diversify export markets, support exporters || Inflation | Escalating import prices, wage pressures | Fiscal prudence, targeted investment || Growth Slowdown | Diminished economic growth prospects | Infrastructure, skills, innovation funding || Confidence Volatility| Declining business and consumer confidence | Policy clarity, public investment || Bilateral Trade | Benefits from U.S.-UK trade deal | Strengthen and expand trade alliances |
- To address the economic growth slowdown, the OECD recommends strengthening public finances by delivering on the government's ambitious fiscal plans, which include targeted spending cuts, closing tax loopholes, and raising some taxes.
- Critics argue that the UK's rigid fiscal rules, such as the requirement for the current budget to be on course to be in balance or surplus by 2029/2030, unnecessarily restrict government spending.
- To boost investment and revive productivity growth, the OECD encourages the government to focus on supply-side policies, such as re-evaluating council tax bands based on updated property values and eradicating distortions within the tax system.
